In days gone by the bond was a staple of investment portfolios held by Brits. The fixed interest rate and defined date at which the bond’s initial value is redeemed made it very convenient for financial planning. Despite the popularity of bonds a few decades ago, very few of those in the UK now investing online in ISAs or SIPPs own bonds directly. If they do have exposure to the bond market it is through bond funds.
However, in a recent article for The Telegraph, Paul Killik, founder and CEO of wealth manager Killik & Co., explains why he doesn’t think bond funds offer the same financial planning advantages. He hopes one positive outcome of Brexit could be the rejuvenation of a ‘proper sterling-based bond market’ that is tailored to the needs of retail investors.
Equities are an ownership stake in a company while bonds are loans made to a company or government. They come with a bond ‘coupon’, which is a guaranteed interest rate to be paid to the holder. They also have a fixed expiry date at which point the bond issuer is obliged to repay the initial capital value loaned to it. The risk for the investor is that the company or government that borrows the money via a bond issue is unable to pay back the initial sum or interest promised.
In a similar way to how banks set loan interest rates according to the wider market conditions and credit worthiness of the borrower, bond issuers set the coupon they offer based on what the market will require to be ready to take on the risk of lending them money. The better the credit rating of the company or government, the lower the interest rate they will be able to offer. Higher risk means a higher interest rate. Regulated, listed bonds can also be traded before their expiry on the London Stock Exchange. Again, market dynamics will have an influence might mean the price and interest rate offered on second-hand bonds differs to some extent to what they were originally sold for. But this means that bond holders have some liquidity and can sell a bond early if they need the money or have concerns around the future credit worthiness of the issuer.
But bonds still exist and if I’m investing online into an ISA or SIPP I can still buy them, no? In Paul’s opinion, yes and no. The Eurobond market largely replaced the old London Stock Exchange bond market and this market was not friendly towards retail investors, unenthusiastic to offer bonds in retail-friendly value denominations. The EU also released a ‘Prospectus Directive’ in 2003 which meant that bonds could only be bought and held individually in minimum amounts of £100,000 or €100,000 unless a specialised ‘simple language’ prospectus was created for retail investors.
Most issuers were concerned about the potential risk of their ‘retail investors prospectus’ being considered as not meeting the ‘simple language’ requirements and decided retail offerings were not worth the trouble. This pushed most retail investors looking for the stability bonds offer into bond funds which Mr Killik doesn’t believe offer the same financial planning advantages of individual bonds as they lack a defined capital return date.
Despite the introduction of the LSE’s Order Book for Retail bonds offering access to retail investors, the Prospectus Directive has meant enthusiasm of issuers has been limited. Mr Killik hopes that Brexit can mean a new UK regime for bonds which will unite the prospectus requirements for retail and institutional investors. This, he believes, can pave the way for a new sterling-based bond market that will be retail-investor friendly and re-introduce a formerly favourite vehicle for Brits investing online into ISAs and SIPPs.