MIDAS: Bond market opens doors to small investors

By JOANNE HART
Updated: 17:23 EST, 23 January 2010

Last last year, Midas asked readers to tell us more about the types of investment they like to make, the amount they tend to put in and if they would like to branch out beyond shares.

The answers to our questionnaire were illuminating and we plan to act on them this year. Many readers said they wanted to explore new types of investment so today marks the first in a series of columns about different assets.

Companies have been raising money through bond markets for decades. In the Sixties, about half of all the trades carried out on the London Stock Exchange related to what were then known as ‘unsecured loan stocks’ or ‘debentures’, now more commonly known as bonds.

Bonds offer more protection than shares because the initial outlay is always repaid unless the company issuing the bonds goes bankrupt.

Since then the market has continued to thrive, but it has become the preserve of big institutional investors. It has become the norm to issue bonds in minimum denominations of £50,000 or even £100,000, making the sector inaccessible for all but the richest private investors.

But the London Stock Exchange is about to launch a ‘retail bond’ market, specifically aimed at individual investors.

Starting on February 1, the market will allow individuals, through their brokers, to buy and sell bonds in denominations of about £1,000.

The bonds will be listed on the LSE, like shares, but the way they are structured and their appeal as an investment are very different from traditional equities.

Bonds are a bit like loans. Companies borrowing in the bond market have to repay the cash at the end of a fixed period and interest – known as a coupon – is paid every year. 

The coupon is invariably higher than any interest available from ordinary bank or building society savings accounts because companies have always been considered riskier than banks, although events of the past two years have shown that banks are not always the safest havens for savings either.

The coupon a bond pays will depend on how sound the company is perceived to be. Riskier companies have to pay more. Solid ones pay less.

The amount also varies according to prevailing bank interest rates, the date on which the bond issue matures and investor demand. Coupons are normally set a number of percentage points above the Bank of England base rate, but when there is strong demand, this may be set just one or two points above the base rate. 

When investors are worried about risk, the coupons will be higher. Manchester United Football Club, for example, issued a bond last week, maturing in seven years and with a coupon paying between 8.75 and nine per cent, according to demand.

Earlier this month, Prudential, perceived to be a much stronger business, issued a three-year bond with a coupon of just 3.375 per cent. For ordinary savers used to rates as low as 0.5 per cent, bonds appear to offer much more generous levels of income.

They are usually safer than shares, because the initial outlay is always repaid unless the company issuing the bonds goes bankrupt.

And the annual income is more certain than a dividend because the coupon - or interest - is fixed from the start.

But bonds are not risk-free. First, if a company goes under, investors will almost always lose their money.

Second, the price at which bonds are traded varies according to views on inflation, interest rates, the economy and the company itself.

When the market is worried about inflation, rising interest rates or the company doing badly, the price of its bonds will fall. So a bond worth £1,000 on the day it was launched could be traded at £900 if the market suddenly becomes concerned about inflation, or the company announces some seriously bad news.

Conversely, if economic news is good and the company is doing well, the bond price could rise to £1,100.

For investors who simply want to buy a bond issue on the day that it is launched and keep it until it matures and the initial sum they invested is repaid, the price at which the bonds trade in between is immaterial.

But for those who want to buy or sell bonds after they have been launched, the price can make a big difference. The new LSE market should be extremely helpful in this respect as bond prices will be displayed every day on the website in much the same way as share prices are now.

And, in time, it is hoped that denominations come down from £1,000 to £500 or even £100. Corporate bonds are not for everyone. But for investors looking for an alternative to shares, they are certainly worth exploring.

A principled decision on Cadbury

Two weeks ago it seemed as if Cadbury had a strong chance of staying independent. But last week the board recommended an increased offer that equates to about 850p a share from persistent US suitor Kraft.

The new deal, which values Cadbury at about £11.6 billion, will see investors receive 500p in cash and 0.1874 of a Kraft share, as well as a 10p special dividend, for every Cadbury share they hold.

Investors can also ask for more cash or more shares and, if other investors want to do a swap, Kraft will arrange it.

Midas verdict:  When Midas recommended Cadbury just over a year ago, the shares were 574p. Today they are 832.5p. Kraft is taking on billions  of dollars of debt to fund
the deal so investors who  accept the bid will be left  with shares in a company  facing an uphill struggle  over the next few years. For those who still feel they want to try to keep  Cadbury British, download our letter at www.thisismoney.co.uk/cadbury.

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