By ADRIAN LOWCOCK 01/04/2010
One of our competitors has been prominently promoting an ‘exciting’ opportunity to invest in a corporate bond yielding 7%. Whilst this might appeal to some, we would caution investors to be wary of investments sold on a ‘headline’ rate and ensure that they have a good understanding of any investment’s underlying risk.
The term ‘bond’ is used to describe a wide range of investment products from Savings Bonds to Investment Bonds, as well as Premium Bonds. The investment currently being promoted is a new bond issued by Provident Financial (7% 2020), an individual corporate bond. A corporate bond describes any debt issued by a company and is an investment, not a cash deposit. There are many different corporate bonds in issue, each offering different terms and different levels of risk, from investment-grade, lower risk bonds to high-yield bonds (sometimes described as ‘junk’ bonds).
What should you look at when buying an individual bond?
There are many things to take into account when selecting an individual bond. We suggest you consider whether you know enough about any particular opportunity before investing:
- Know the background of the company. It is important to get an idea of the company you are investing in and understand the risks of the business.
- Understand the security of the bond. A bond can be secured against specific assets of the company or might be unsecured. The nature of any security will impact on the risk of the bond.
- Sensitivity to interest rate movements and inflation. Bond prices are not only affected by the strength of the company but also the outlook for inflation and the level of interest rates in the wider economy. This sensitivity to interest rates is determined by the coupon (fixed level of interest) payable on the bond and how long it is until the bond matures.
- Financial Protection. Individual corporate bond investments are not covered by the Financial Services Compensation Scheme and if the company goes bankrupt you could lose some or all of any money invested.
- Diversification. How does the bond fits within your portfolio of investments? We generally do not suggest that investors hold just one bond in their portfolio. By spreading your investment across a number of different bonds, you will be able to reduce your overall level of risk.
Provident Financial 7% 2020 Corporate Bond
Provident Financial is a sub-prime lender in the non-bank financial services sector, a comparatively high risk industry. The bond being issued has been rated BBB+ by credit rating agency Fitch’s, making it an investment grade bond (one rating lower and it would be a high yield or ‘junk bond). The existing Provident Financial 8% 2019 bond currently has a yield to maturity of 7.3%, the new issue would be less at 7%. However, the 2019 bond is only readily available to bond fund managers. Provident Financial is paying independent advisers commission to sell the 7% 2020 bond, which has rarely happened before.
Our view
Deciding which individual corporate bond to buy is a complex process. It is equally important to decide when to sell. Professional bond fund managers will rarely hold an individual bond for its entire life, deciding to invest and sell depending on their view of the attractiveness of a range of fixed income investments against the backdrop of interest rates and inflation. It is our view that most investors should access bonds via skilled and experienced managers who are able to dedicate more time and resources to researching the right bond. They can offer yields of around 6%, but are not as risky as an individual bond, plus there is the potential for capital appreciation.
Our recommendations
We currently prefer strategic bond funds where the manager has the flexibility to move anywhere within the bond universe and take advantage of opportunities as they arise.
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If there is anything you wish to discuss please call one of our investment professionals on 020 7189 9999.