Corporate bonds – the essential guide for investors from the experts at Cauta Capital 

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This is the essential guide to investing in corporate bonds – for investors – from the experts at Cauta Capital.  

Cauta Capital has created the essential guide to corporate bonds for investors. Here we look at the pros and cons of investing in corporate bonds and explain the different options available. 

Every day entrepreneurs and start-up businesses pop up all around us, with fledgling companies and new and innovative products and services. Often, they’re started with seed-investment, Venture Capitalist funding or savings, and the initial funding for businesses can soon dry up. 

To enable them to move to the next level, from a seedling to an established business, they need more investment. And this is where corporate bonds come in to play. 

Investing in corporate bonds – the basics

For new investors let’s start at the beginning: with simply answering the question what is a corporate bond? A corporate bond is a money-raising option for businesses. Think of it as a certificate of debt issued to investors by the company. 

Investors lend money to the business and receive an IOU that promises a return on investment (ROI) after a fixed term. When the bond matures the investment amount is returned in full. 

Corporate bonds also come with a ‘coupon’. This refers to the amount of interest paid to bond investors. As long as the investor holds the bond, they will receive payment of the coupon amount every year until it matures. This coupon is a fixed amount, set at a percentage of the bond’s cover price. 

While this sounds broadly similar to a savings bond, or a savings account with fixed term interest, it differs in a major way. Corporate bonds are termed as investments, not savings accounts. 

How does a corporate bond work?

As an example, an investor buys a ten-year bond with a cover price of £10,000 and a 5% coupon. They will get £500 every year in interest from the coupon. After ten years they will also get the £10,000 back. 

However, this means that the bond is only safe if the issuing company remains safe, leading to high risk investments. The key risks are: 

  1. The issuing company fails. If the business you’re investing in goes down, or even just scrapes by, you could lose a percentage (or all) of your money. 
  2. The liquidity of the investment. If you want, or need, to sell your corporate bonds, will you be able to? Would someone offer a fair price, or would you lose out because you have to pay a broker to be the middleman? 

What differentiates a corporate bond from a fixed rate savings product? 

A publicly listed corporate bond can always be bought and sold. So, you don’t have to wait until the end of its lifespan to sell it and drop your investment. This is the main difference between fixed rate savings and a listed corporate bond. The latter is much more flexible. 

If you bought a listed corporate bond with a ten-year contract, you don’t have to wait until the time is up to cash it in. However, if you choose to sell the bond on before it reaches maturity, the price will be dependent on market rates. Therefore, at any moment you choose to sell it could be worth more or less than you initially paid. For example, you might only get £90 of every £100 you invested. That’s the downside. But the upside means it could be worth more and not only will you recoup your investment, you’ll also make capital gain. 

Corporate bonds that are trading for an amount less or more than their initial price are defined as ‘trading above’ or ‘below par’. If you buy a second-hand corporate bond, therefore, you will be repaid the bond’s value when it matures, and the coupon interest rate up until that point. However, if you paid below par for the bond, then this will mean you get less money in return. 

How to trade listed corporate bonds

Usually, investors will buy corporate bonds through a fund, which invests in a variety of different companies to spread the risk. Of course, this does mean paying fees to the fund manager. 

A corporate bond fund manager should know how to take advantage of the ups and downs of the market so that they can deliver a return from the bonds in the fund, and an extra amount from buying traded bonds below par and selling on for more. The downside to this kind of bond fund is that its value will depend on lots of different deals. It’s can also be affected by the market’s view on possible interest rate fluctuations. 

If the fund manager makes an error and invests in companies that fail, or they take too many risks that don’t make returns, then the fund can lose money. So, if you invest in a bond through a fund and choose to sell in a few years’ time, you could easily discover that the fund is underperforming, and you don’t get your full investment back. 

A skilled bond fund manager could mean you get a significant profit and, remember, that the risk is spread across a variety of companies.

Individual corporate bonds mean you’re banking on that one firm not failing, going bust, or otherwise affecting your investment. 

How do retail bonds differ from corporate bonds? 

The Order Book for Retail bonds was launched on the London Stock Exchange in 2010. Known as Orb, the idea is to encourage more companies to attract individual investors with corporate bonds. 

They’re also known as either retail bonds or retail corporate bonds and are traded using brokers and investment platforms. Companies including Tesco Bank, Severn Trent Water and National Grid have all released popular corporate bonds. 

Because the minimum investment amount for retail bonds is low (between £100 and £1,000), they’re more attractive to individual investors. They’re targeted specifically at individual, small investors and so are considered completely separately from the much larger institution-dominated corporate bond market. 

What are Gilts? 

Gilts are bonds backed by the UK Government, and are the lowest risk investment bonds available. In the same way as corporate bonds, investors are essentially lending money in return for the coupon interest payment and getting the amount back in full. The Government uses the money for public spending. 

They are traded on the open market, however, which does mean if you sell before maturity you may not get back the whole amount initially invested. But it also means you can buy them below par (par is 100p) and wait until redemption to make capital gains. 

The price of gilts goes up when the base interest rate is cut by the Bank of England and decreases when the base rate rises. 

What are mini-bond investments? 

These products are unlisted, and therefore can’t be traded on the LSE. They are different to retail bonds, Gilts and corporate bonds. They’re basically corporate bonds for private investors, so the money goes directly to businesses. At the end of the term, the investor should get their money back, as well as the interest they’ve already been issued. However, they’re higher risk and you could lose all your money. 

Things to be aware of when considering retail or mini bond investments

There is no doubt that these kinds of bonds are a risky investment. Before making a decision, consider the following: 

  • They’re not protected under the Financial Services Compensation Scheme. 
  • You should do extensive research before investing. 
  • Ideally, you should get an expert to help you. 
  • The higher the return offered, the higher the risk you are taking. 
  • You must research the likely longevity of the issuing company to understand the prospects of their bonds. 

How do companies decide on the interest rate offered? 

The issuer sets the interest rate return on a corporate bond. How they come to the decision depends on a variety of factors. These include current interest rates and whether they can be expected to rise. The most important factor is how stable their company is perceived. 

Smaller companies sometimes offer corporate bonds with huge returns. The risk is heightened by the possibility of the issuing company going bust. Investors should remain cautious. 

Corporate bonds – yes or no? 

At a time when interest rates are very low, and interest paid on savings accounts is negligible, corporate bonds can be seen as a good investment decision. 

However, they do carry risks as outlined above, and they are not the same as a savings product. Inexperienced investors should always get independent financial advice before buying any corporate bonds. With the right advice, and an understanding of the market, they can be a great choice. 

About Cauta Capital

Cauta Capital is a UK-based company, investing in asset-backed property developments, secured joint ventures and private equity projects.