What is a bond?
Updated: Jul 31, 2020
What is a Bond?
In light of recent events, Investors face a constant dilemma over which assets, such as shares, bonds and property, to invest in. The answer is often that a mix of assets can help meet your goals. Different investments can perform well at different times.
For example, when shares languish due to unfavorable market conditions, corporate bondscan act to provide a consistent return. This would be considered to be sensible diversification.
What is a corporate bond?
A corporate bond is company debt. If a company needs to borrow money it can go to a bank and ask for a loan or it can issue a bond for investors to buy.
Why would a company issue a bond rather than borrow from a bank?
Companies predominantly issue bonds to raise capital which they then use to either fund a project or business activity that generates profit for the company.
The company then pay bond holders their fixed returns. This is often more flexible than obtaining a corporate bank loan and enables the company to continue to raise capital for new projects/business activities.
What do I get in return for investing in corporate bonds?
You will receive a regular interest payment, which is also referred to as a coupon, and are typically paid semi-annually or quarterly for the duration of the bond. At the end of the term of the bond, which is pre-agreed, the company is due to pay you your money back.
How much interest will I receive from a bond?
This depends on the company issuing the bond
The duration of the bond has a strong influence. In general, the longer the duration, the higher the interest rate, with investors being rewarded for leaving their money invested for longer periods.
Do I receive any other benefits from being a bondholder?
As a creditor to the company, a major benefit of being a bondholder is that you are higher on the list of investors when it comes to getting your money back if the company were to fall into financial difficulty.
Shareholders, in contrast, are owners rather than lenders and are among the last to receive any pay out. Shareholders, in fact, rarely receive anything in the event of bankruptcy.
A key factor is to understand the level of security that is in place.
How Secure is my money?
A bond is a legal structure that allows an investor to benefit from receiving a fixed return without investing directly into the business activities of the company. The risk to return the money lies fully with the company issuing the bond.
The level of security provided will either be asset backed or insured in some shape or form, however that needs to be qualified. Insurance policies often have clauses which make claims invalid and depending on what assets are in place can also affect the overall security of client capital.
Typically bonds are secured by physical assets whose value can change at the drop of hat, additionally should the company issuing the bond negate to meet their financial obligations and have their assets liquidated, they first need to be valued, then put up for sale, and the proceeds of which are returned to investors. If however the value has dropped significantly, the likelihood of investors receiving their money back also reduces.
A less utilized form of asset backed security are liquid assets i.e. cash and quotable stocks. It should come as no surprise that investments backed by actual cash offer the most secure form of protection over a client’s invested capital especially when a regulated security trustee holds debenture over those liquid assets.
So, should I buy corporate bonds and not shares?
As always in investing there is a risk-reward trade-off. Over very long periods, shares have tended to return more than corporate bonds, but they also carry far more risk.
Investing in equities has always been a long term investment approach and in the midst of a crash, if you do not have the capital to ‘double up’ and ‘buy the dip’ then you face a portfolio which has been severely devalued and can take over a decade to realize profit unless some very astute decisions are made and even then there is no guarantee of success, certainly not in the short term.
When investing in equities you have to be prepared to be in it for the long haul as that’s where the results are typically seen.
When it comes to what type of bond to invest in, the sensible approach would be to invest in a company whose main business activity are not linked to the global equity market, commodity market or real estate. Businesses that are not correlated in any way to these sectors tend to fare well in the face of a global pandemic or worldwide lockdown.
So why would I consider investing in company bonds rather than shares?
As bonds offer a fixed return, and can provide capital security, it offers downside protection against the more volatile asset classes held within a portfolio.
Tthe relative stability of corporate bonds could help balance a portfolio and smooth those years when markets are more volatile.
What should I look for in a corporate bond?
1. Level of returns offered – Between 8% and 14%
2. How client capital has been secured – Liquid Assets ‘cash’ offer the best level of security and ensure a security trustee hold a legal charge ‘debenture’ over those assets.
3. Information available – Should include Fact sheets, IM, Supporting Material (DD) making it easy to understand.
4. How money is being invested (what purpose) – Bonds linked to Equities/commodities/property are going to be higher risk as directly affected by the global pandemic. Bonds not linked to those areas are better positioned to deliver as designed.
5. Listed or unlisted – Stock Market listed bonds are predominantly for use with investment platforms and have been through strict regulatory compliance. As platforms come with fees and charges to the investor, its’s not suitable for everyone and the minimum investment levels tend to be upwards of 100k.
If a company has both options available, then the level of security offered will be the same across both the listed and unlisted versions of the bond. The big plus point is that the company are able to offer flexibility to investors who do not wish to use platforms and would prefer to invest directly by using the non-stock market listed version and therefore benefitting from a lower minimum investment and zero fees.
6. Minimum investment – Corporate bonds typically start at 50k with a raise from 50m upward. If you see a bond raise for 5m offering 10k minimums it's a mini bond and are to be avoided as they do not offer the same level of protection as a corporate bond.
7. Historical performance/client returns: Although historical performance isn’t a prediction of future performance, if you or your client is a cautious investor, knowing that a bond has been paying out consistently for more than a year and throughout the global pandemic should indicate a better option than a product that has not launched yet.
9. Regulated or unregulated – A large percentage of corporate bonds are not regulated as they are not seeking to raise capital via pension companies or tier one platforms and therefore don’t at the moment require regulation. Good practice however is to ensure that the security trustee holding debenture over the assets is regulated, as are the paymaster, registrars and solicitors who govern the structure of the bonds. In some cases also the trading environment in which the business activities are delivered may also be regulated.
We hope that this overview has and will help when positioning bonds to your clients.
To learn more about how our fixed income bonds can support your clients contact us at:
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