As new rules come into force opening up UK corporate bond markets to retail investors, Aberdeen Investments outlines the key points that investors should consider.
The UK’s Financial Conduct Authority has this month outlined changes which should make it easier for retail investors to take part in corporate bond offers, as well as company fundraisings and stock market flotations.
The move is part of the UK Government’s efforts to get more people to invest, with the Chancellor keen to promote an investment culture in the UK and boost retail participation in the UK’s financial markets.
Corporate bonds have historically been the domain of institutional investors, rather than retail investors, due to complexities around documents and disclosures, with many bonds having a minimum subscription level that would typically be beyond the reach of retail investors. The new rules mean that retail investors should now be able to subscribe for bonds alongside institutional investors.
The move comes amid calls for a market standard where all Plain Vanilla Listed Bonds (PVLBs), along with all UK IPOs, include a retail tranche by default.
However, before retail investors rush to invest in corporate bonds, it’s important to know some of the potential upside and downside risks for investing in the asset class.
Luke Hickmore, Investment Director – Fixed Income, at Aberdeen Investments says: “We applaud the Government’s move to open up the corporate bond market to retail investors and help continue to encourage an investment culture in the UK. The number of companies coming to the sterling investment grade market is declining and any move to help bolster this, and encourage portfolio diversification, is welcomed.
“But it’s important investors understand the risks and levels of due diligence needed. There are currently over 950 investment grade UK corporate bonds to choose from, and investors need to ensure they understand rating quality, the yield and how long it will take to get your money back, before choosing whether to invest in any of them.
“It’s also important to consider exit liquidity, should you want to sell your bonds. This can be patchy in the retail market – it’s not like a bank account, if you want to sell there needs to be buyer on the other side.
“In our view, retail investors may like to consider the short duration market, with bonds that mature in a period between one to five years. This offers a good yield and lowers exit liquidity risk.”
Buying directly compared to holding a fund
Buying corporate bonds directly does hold some advantages for investors, including no management fees compared to holding a fund that invests in bonds, as well as a clear timeline for when they will receive their money back, assuming no defaults.
While for tax purposes, if a retail investor buys sterling corporate bonds, they may not have to pay capital gains tax, though they will have to pay income tax on the interest received from the bond’s coupon.
However, it’s important to note that corporate bonds can be higher risk than the type of government bonds that retail investors have typically bought in the past, such as gilts. This means they require a higher level of research to avoid any default risk.
Such research includes analysing the cash flow and balance sheet strength of the companies issuing the bonds, as well as how much companies can afford to service their debt (through metrics for cash generation and others such as EBITDA to net debt), and any risks that may affect this. Almost all bond funds will have teams that conduct this research.
Holding a bond fund allows retail investors to outsource this time-consuming due diligence for each available bond on the market. It can also offer greater diversification by enabling investors to hold several bonds of varying geographies, sectors and maturities at the same time without needing to do extensive due diligence on each one.
Mark Munro, Investment Director – Fixed Income at Aberdeen Investments and manager of Aberdeen’s Short Dated Enhanced Income Fund, says: “Another option for investors looking for a diversified portfolio of bonds, but with potentially lower credit risk, could be strategies that invest in short-dated bonds. These are bonds that are set to mature within three years, and we believe they offer a sweet spot between offering a yield above cash but with the possibility of lower risk and volatility.
“An investor could invest in some of these bonds directly, but owning them via a fund enables access to a wider range of bonds globally, safe in the knowledge that a team of analysts and managers has done the research for them to pick the bonds that offer the best opportunities for potential return.”
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The writer’s views are their own and do not constitute financial advice.
This information should not be relied upon by retail clients or investment professionals. Reference to any particular investment does not constitute a recommendation to buy or sell the investment.
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