Retail Bonds – The Risk and the Rewards

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Retail Bonds seem to be one of the most popular investment opportunities available in the UK Financial Services market right now, with small investors flocking to hop on the band wagon and earn themselves some ‘easy’ money. The London Stock Exchange (LSE) launched its Order Book for Retail Bonds (ORB) in February 2010, offering continuous two way pricing for trading in retail size corporate bonds. This is a transparent and open market for trading in a range of retail bonds.

Since then small investors have been buying up retail bonds, attracted by the simplicity of transactions and their cost-effective nature. With a key aim of increasing the distribution of bonds, though opening up the market to private investors, the LSE really does seem to have hit on a winner. ORB allows companies which want to raise funds without borrowing from the banks, or selling shares, to offer retail bonds as a way of securing capital.

The retail bonds can be held by the investors for a fixed term (typically three or six years), and pay a quarterly fixed interest rate until the bonds mature, at which point investors are repaid their initial investment. These retail bonds carry greater risk than cash on deposit in a high street bank, and this is reflected in the higher returns which investors receive for taking on greater risk. The minimum amount of investment can be relatively low (often as little as £2,000) while interest earned on the bonds is above the rate of inflation (and usually between 5% and 7.5%).

Several high profile household names have issued retail bonds, including Tesco, and Enterprise Inns. Retail bond investors are not only tempted by the high interest rates involved, but by the added extra opportunity to save on costs by cutting out the traditional middleman; the bond fund manager.

Since the launch of ORB, retail bonds have been described as the very latest investment opportunity. They seem to be good for companies and good for investors – a veritable ‘win-win’ financial product that sounds almost too good to be true.

You know what they say about something that sounds too good to be true, it usually is. So, let’s take a closer look at retail bonds to see some of the highlighted drawbacks or weaknesses – flies in the ointment so to speak. One of the downsides is that bonds need to be held until maturity if they are not tradable. However, this is perhaps offset by the relatively short life of the retail bond.

Retail bonds don’t provide the same level of financial rewards as investing in shares, but they don’t usually involve the same level of risks either. Because the investor is lending money to the company issuing the bonds, there is no potential for capital growth, just the interest paid and then the return of the capital on maturity.

Retail bonds are usually ‘unsecured’. If the issuing company goes bust, bondholders may have to wait in line with other creditors and could lose their capital entirely, although they will stand ahead of shareholders. Unlike cash deposits in your bank, not all retail bonds are covered by the Financial Services Compensation Scheme (FSCS) so there are associated risks involved with investing in them.

But last year, CBD Energy raised £7.5 million to invest in UK solar energy projects with its Secured Energy Bonds offering. These bonds are secured against the solar projects themselves. That means that if the issuing company does go bust, the installations can be sold to an alternative organisation i.e. they have real value. With Secured Energy Bonds, once the solar projects are operational, output is predictable and maintenance costs are low. Moreover, income can be generated from the Feed-in Tariff, which was introduced in 2010 in order to support businesses, communities and individuals to generate clean, green energy.

[This post is supported by Energy Bonds. Image: David Ohmer]

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