In this episode of Good Money Guide TV We’re here with Rezaah Ahmad from WiseAlpha. Today, we’re going to have a quick chat about bonds, where they fit into portfolios, what the pros of having bonds are, what the risks of owning bonds are, and also, how to buy them, and we’ll touch briefly on all the bond scams that are around at the moment, and Rezaah will give us some quick tips on how to spot those.
Good morning. Welcome to Good Money Guide TV. We’re here with Rezaah Ahmad from WiseAlpha. Today, we’re going to have a quick chat about bonds, where they fit into portfolios, what the pros of having bonds are, what the risks of owning bonds are, and also, how to buy them, and we’ll touch briefly on all the bond scams that are around at the moment, and Rezaah will give us some quick tips on how to spot those. So Rezaah, thank you very much for joining us. You’re from WiseAlpha.
That’s right, Richard, thanks for having me.
No, you’re welcome. It’s nice to see you again. So we’re talking about bonds today. Do you want to just quickly tell us what a bond is and how it differs from investing in stocks?
Yeah, sure. So companies raise capital in different ways; sometimes through equity issues but also through bonds. Effectively, what a bond is, it’s an IOU or a loan from individual investors to a company. And in exchange, you get a fixed rate of interest and your capital back at maturity.
And there’s several different types of bonds that vary in risk, depending on where they’re backed. So you have government bonds, you have corporate bonds, and you have junk bonds. So three very different risk profiles. Do you want to just talk us quickly through what those different types of bonds are and risks associated with them?
So the bond market is very big and diverse. And over the last 20 years, you know, it’s trebled in size. It’s now a multitrillion global market. And obviously, within that, there’s a huge range of risk and reward in different types of bonds. One of the oldest forms of bonds are government bonds, so that’s governments who have issued bonds and receive money in exchange for those bonds from investors and banks and other institutions. Generally perceived as the lowest risk type of bond. It’s not absolutely risk-free, as you could see what happened with Greece ten years old, but they generally are perceived to be the least riskiest part of the bond universe.
And of course, they yield the least as well.
That’s right. Obviously, they yield the least. And then you have the investment grade variety, which are corporate, like very large companies like Apple or Microsoft, who have issued bonds, but because they are perceived as very solid and strong, and the credit risk is viewed as a lot lower, they are typically the finder’s investment grade and rated as such by the ratings agencies. And the yield on those will be typically slightly higher than that which you would get on government bonds.
And then gradually, as you move down the risk spectrum, you have a variety of bonds called Senior Secured Bonds, which are bonds where there’s a little bit more debt on the company, so a little bit more risk because borrowers are expecting the company to repay its bonds at maturity, but, you know, they typically have to require some kind of refinancing of the bonds at that point. And so there’s some risk if the company’s not performing strongly, then maybe there’s a little bit of risk. And for that, you know, there’s an extra yield. So we’re talking about the kind of 4-6% bracket. And this is what people commonly refer to as kind of high-yield bonds, which are the kind of lower end of the high-yield risk spectrum. They’re typically backed by assets or security over the shares of the business and any other operational assets that the company may have. And obviously, there’s a lot of variety in the types of Senior Secured Bonds that you have. Those which are backed by real hard assets like property tend to be viewed as stronger, whereas those which aren’t backed by hard assets tend to be viewed as weaker and therefore, compensating with a high yield.
And then you get a more risky form of high-yield bonds or junk bonds, which is a bit of an unfair label that’s been given to them because, you know, I think that was something that was given right at the beginning when the higher bond market was a little bit wild west, a bit like peer-to-peer lending is today. But those types of bonds tend to be unsecured and sit behind more senior debt or senior borrowings, or bank loans that the business may have. And so those bonds tend to yield in the sterling market anywhere from kind of 5-11% or higher, depending on how they trade.
So let’s just talk about the interest you can earn from bonds and how that varies, not just from asset class but also on the individual performance of what’s backing the bond. So when bonds come to market, they generally come to market at a pound, with a coupon attached, which can be anywhere from a few bips to 5, 6, 7%, depending on what it is. But of course, it’s not the coupon that changes; it’s the yield, isn’t it? So if say, for example, you have a listed stock whose bonds… where the coupon when it came to market is 3%, but you can actually buy them and get a yield of 7%, which is obviously very attractive. You know, if it’s a household name that’s trading on the stock market, everybody knows about it and you can get a 7% yield by buying their bonds, but the coupon’s actually, you know, 3%. Why the extra interest payments?
So a bit like a stock, bonds can trade up or down in price. And so like you said, bonds are issued at what we call par or 100 pence in the pound, and you know, you might start off with a 3% coupon in your example, but as the business goes through its life cycle over the coming years, and if the bond’s still outstanding, you know, the risk from that bond might change because the risk of the underlying company might change. So let’s just say, you know, it has a particularly bad for the company, you know, profits drop by half. That will increase the perceived risk by bond holders, and in the secondary market, where these bonds trade, a bit like stocks, you’ll find that the price will drop below 100 or below what we call par. So at that point, when the price of a bond falls below that threshold, what that means is that the yield or the expected return that you would get by buying that bond at that moment in time, before maturity, is higher, because you’re buying the bond at a discount. That discount gives you that extra yield or extra return, and so that’s why the yield might be 6% at that moment in time, rather than when it started at the three.
Exactly. So you know, it’s particularly relevant in the oil sector where profit [warnings] are fairly common; a bond can quite easily drop down to 80 pence in the pound. So in that instance, for example, in order to buy £10,000 worth of that bond, you’d only actually have to pay £8,000 but you’d still get £10,000 worth of interest, which is where…
Yes. And if the company successfully repays that bond, you’ll actually get the 10,000 back. So 2,000 extra…
So they can be used as a speculative tool as well. So what else; you can benefit from the capital of appreciation, the yield will come down. So whilst you’re getting less interest back, you’ll be getting the capital appreciation on the…
That’s right. So if the price goes back from 80 in your example to par, then obviously, you’ll have benefitted from the capital movements and so you’ll be up on that part.
But of course, it’s the other way around as well, if a company’s performing particularly well, the bonds could be quite heavily in demand, so they can be trading at 102 so therefore, the yield would actually be below the… so it’s very much a sort of swings and roundabouts…
And let’s just talk about the pros and cons of owning bonds before we get on to whether or not you should them and where they fit into your portfolio. Top three major benefits of owning bonds?
Well, I mean, the corporate bond market in the UK actually has been one of the best performing asset classes over the last 20 years. So if we think about selling investment grade bonds – that’s the lower risk variety, if you remember – that’s generated 6.1% over the last 20 years, between 1999 and 2019, according to Barclays. And the high-yield variety has generated 10.4% per annum between 1999 and 2019. So you can see that there’s obviously a strong rate of return that’s generated by this asset class. If you compare that to equities, which is the main alternative that people tend to invest in, that’s generated over the same period 5.1%. So actually, for less risk and more reward, you’re doing better off by investing in bonds than you are stocks.
It’s a shame really, isn’t it, because…
And they’re often in the same company, Richard, as well.
Yeah, that’s an interesting point.
So it’s crazy actually.
But I hear it’s one of those things that bonds are often quite seen as a dull asset class, aren’t they? But actually, the thing about investing is the duller it is, the better it generally performs.
That is. The more boring an asset class, the better it is. You know, not everyone wants to go on a wild stock market ride or invest in crazy things like crypto, you know. Bonds have been viewed, rightly or wrongly, as a very dull, boring asset class, but my view, that’s actually what makes them so attractive.
I mean they are actually quite interesting because you have all the sort of benefits of stock trading. I mean you can speculate on the price of the bond as well, but you also have the yield as well.
So we’ve talked about how great bonds are but there are no guarantees in investing. Money is always at risk. So top three risks, from your point of view, for the punters investing in bonds.
So as you said, I mean nothing is a free lunch. There is risk when investing in bonds, and a few things that people need to watch out for are, you know, how a company’s performing. As I said, if performance deteriorates then that will affect the ability of the company to repay its bond and maturity, and that could cause a risk to your capital. If you look at the retail sector, for example, this year’s had a really bad time. And so companies like Thomas Cook lost their shareholders everything and they also lost their bond holders a significant portion of their capital as well.
So on that, generally, bond holders tend to be slightly better protected than equity holders, don’t they? So in Thomas Cook, you know, shareholders lost everything, didn’t they, or as good as, but how did the bond holders end up?
So I think the bond holders ended up with a kind of a high single digit, well, it’s still ongoing, but they’re going to end up with a high single digit, maybe low double digit recovery on their bond, so quite bad in fact. Obviously, that was a slightly different situation. Thomas Cook was more of a retail operator, high leverage in its operations and didn’t have much asset security behind it. So that’s affected it. But a lot of bonds do have security and that’s why it’s very important to look out for whether the bond is a Senior Secured, a secured asset, has secured assets backing it, or if it doesn’t. So for example, Enterprise Inns, the pub operator in the UK, all of its bonds are backed by its property, the pubs themselves, which helps.
And in the case of course listed stocks, it’s very easy to determine how a company’s doing. I mean it’s not guaranteed but you just have to look a chart to see. If it’s going up, the chances are they’re doing okay. If it’s going down, chances are the bonds are going to be more at risk.
Any other risks you can think of in terms of investors holding bonds in their portfolio?
I mean some bonds, they can be called early. What I mean by that is they can be refinanced by the company ahead of its scheduled maturity. And so sometimes, if you’re buying a particularly strong bond which is in demand and the price of the bond is above 100, you know, you need to take into account the fact that your expected return might be a bit lower if the company refinances ahead of maturity. So there are a few quotes like that, but all of those details are pretty well described by a prospectus or on a stock market’s website.
And for those people who are thinking of buying bonds for their portfolio, what sort of global macro event should they be looking out for? What tends to affect bond prices, you know, within the economy, and what should people either look for as an opportunity to be buying or take as a warning signal that perhaps now’s not quite the right time?
So I think it’s very important to distinguish the different segments of the bond market. So if you think about the government bond market, that behaves very differently with macro drivers than things like high-yield bonds, which will be more driven by the performance or the credit risks or the individual company that’s borrowed the bond. And investment grade behaves somewhat in between. So let’s give you an example. So earlier this year, there was a lot of concern in the UK about Brexit, you know, what’s going to happen with the economy, slightly weaker job numbers, slightly weaker growth numbers. People then in the bond market decided that a flight to quality was investing in higher rated assets or less risker assets was a good call, and so they herded into investment grade bonds. And those have performed incredibly well this year. You know, 12% return, actually in line with the high-yield market, so for less risk, it’s actually performed very well.
So you know, there are different drivers that do that, and the high-yield market, you know, macro events can play a part. So for example, if rates change, Central Bank rates change, that can obviously affect the desirability or the attractiveness of a bond. So let’s just say you’ve got a high-yield bond, which is issued at 5%, but the Central Bank moves its rates from 1%, Bank of England decides it’s going to increase that to five. So it’s quite a big jump but hypothetically speaking, then there’s no rationale to hold a higher risk security when you can just put your money in a savings account, which’ll be there or thereabouts the Central Bank rate.
On that, bonds are particularly relevant at the moment because interest rates are so low. You just have to compare the rates of any high street savings account, or even any savings bond issued by a bank, and they’re dismal. I mean you’re lucky if you’re getting one to one and a half per cent, and that’s only a small amount of money. So in terms of investment bonds, do you think everybody should have exposure to them, and do you think they should be part of everybody’s portfolio? And then of course, we’ll get on to how to buy them and where WiseAlpha fits in.
Well I may be biased because I run the UK’s leading digital bond market, but I believe that every investor should have a significant portion of their portfolio in bonds, and particularly across the risk spectrum. So not just government bonds but also some investment grade and high yield in there as well. So we’re very much an advocate for a larger exposure towards the asset class in holdings. And as I said, you know, the numbers don’t lie. Bonds have generally across the board, for both investment grade and high yield, have delivered better risk-adjusted returns than equities over the last 20 years.
And of course, it’s very easy to buy bonds. For most people. You know, you can go to your stockbroker and as easily as buying a stock, you can dip into the market and buy government bonds or many corporate bonds. But as you said, you run the UK’s leading bond market. Just tell us a bit about WiseAlpha. What is it? How does it differ from just going and buying bonds through the stockbroker? What does WiseAlpha do and what are the advantages?
We’re a very unique business. So what we do is we’re leading the democratisation of the bond markets. What I mean by that is we make bonds accessible by fractionalising them into very small pieces so that people can build portfolios. Anybody who’s been involved in the bond markets knows that most of the corporate bonds that are issued have very large minimum transaction sizes, minimum denominations, and they tend to be traded on an over-the-counter basis, so off exchange, with large banks. So what that has meant is that the bond market has really been held within a very closed circle of ten big banks and about 150 big fund managers and wealth managers at the side. You know, so individuals have had a very hard time getting access to the bond market. What we’ve done is actually opened up the entire bond market to investors so they can buy both investment grade and high yield bonds on our site from leading UK companies, but they can buy them in minimum chunks of £100, rather than £100,000. So it basically means that individuals can access corporate bonds in a way that they could never have before.
So just to take an example, you know, there’s a listed stock in the FTSE100. It’s issued some bonds. The minimum ticket size or the minimum amount you can buy is £100,000, which is fairly common.
Having said that, there are a small segment of what we call retail bonds, which are available via your normal stockbroker. Those are issued on the London ORB, but they tend to have a very small selection. But there is some small variety that is available.
Of course, but in this particular example, we’re looking at a bond that’s say yielding 7% on a FTSE100 company. As you said, you fractionalise the bond, so how do you do that? How do you give retail customers access to a bond, where normally, there’s £100,000 minimum ticket size?
Effectively, we act as a wholesaler. So we buy the £100,000 in the beginning. Then we issue fractional bonds, which are effectively, people are getting a share of that big bond. And then we sell that on our market on our site. So in that way, it’s a bit like the fractionalisation of the stock market, which is going on right now.
It’s huge. Everybody’s doing it. Everybody seems to be fractionalising.
It’s fractionalised in the States on stocks. You know, it’s a massive thing.
You can see why in the States though, can’t you? It’s actually very much, you know, the exact reason why you’re doing what you’re doing, isn’t it, because Apple, you know, what’s Apple trading at? $217 or something like that? So if you want to one Apple share, that’s $217. So you have everybody coming in democratising it, saying…
It’s worse in the bond market.
You can buy $10 worth, you know, just to get people into investing, or you can buy…
That’s exactly right, but it’s even worse in the bond market. I mean it’s £100,000. You know, for most people, they can’t even afford one bond.
So once they buy these fractional bonds, where do they sit? Where’s their risk? Where’s their money? How protected are they? So I’m a customer and I come to your website, I want to buy £500 worth of a bond that’s yielding 7% or five grand’s worth of bonds that are yielding 7%. You know, who do I pay for the bonds? Who am I contracting with and where’s my money and how do I get it out, I suppose are the questions that people want to know.
Sure. Well on WiseAlpha, because we have a fractionalised bond product, people are effectively buying a small piece of an underlying bond through WiseAlpha. So they’re contracting directly with us, but obviously, it’s all backed by the existing bonds that are trading. If you buy it direct via a stockbroker, so there are, as I said, limited selection, then you’re contracting directly with the company. And so, you know, you can hold that in your stock portfolio as well. But in general, when you think about the riskiness of a bond and how do you compare the risk, let me give you an example. So for example, you’ve got Tesco bonds. They’re now rated investment grade after slightly dipping into kind of high-yield territory for a little while, and you know, you can buy the stock but you can also buy the bonds. Obviously, the bonds are a lot lower in risk. They don’t move around as wildly in price. And then you’ve got the other side of the coin where you’ve got, for example, Aston Martin, which is one of FTSE’s worst performers this year after IPO-ing, you know, where its stock has fallen 75%. But then the bond, which actually started off as a yield and a coupon of 5.5%, you know, has dropped very slightly, still actually generated people returns this year, so while the stockholders have lost 75% of their money, bond holders are sitting pretty at the top of the capital structure. May not have made a massive return but they’re generating income of 5.5% per year, where actually, the current yield is around eight because of prices below par.
What about new issues? We’ve touched on ORB recently. You know, a few years ago, there was a big push. It was actually a great time for bonds because anybody issuing a bond would try and get it on ORB, try and provide a bit of liquidity to provide for clients, and there was a good opportunity for retail customers to a) make a bit of money in the short term because quite often, the price would rise because there was a fair amount of demand for it. You know, new issues, they’re not going away. People will always be issuing new bonds. Are you going to provide access to new issues through WiseAlpha?
Yeah. We cover the entire bond market so we have ORB issues as well. But it so happens that this year, there’s been zero issuance. So really, most of the issuance has happened in the big institutional markets and so, you know, if you want a new issue on a bond, basically, WiseAlpha’s the one venue in the UK for that, or has been this year. And you’re probably going to ask me well, why is that, that’s kind of crazy, right? Why aren’t corporates allowing their bonds to be put into the hands of everyday investors? Why is it just the financial league, the fund managers who are getting access to these things? Well, I think it’s twofold. You know, one, it’s the nature of the way that the banks, who are arranging these issues, want to keep control of the bond market, but it’s also the ease of issuance to very large buyers. You know, it’s much easier to sell ten or twenty big institutions than it is to sell to, you know, 100,000 small individual investors.
Exactly. And indeed, do they need them?
Well, that’s the question for a corporate; does it really need to raise funds from individuals? Obviously, the other big thing is the highly regulated nature of the bond market, you know, since the Prospectus Directive and then the MiFID rules have come in, it’s kind of disincentivised people from wanting to sell to retail, even though they can.
Yeah, it’s interesting. We were talking to PrimaryBid, who are democratising as well, you know, the new issue market, and you know, one of the points there was why don’t retail investors get access to hot new issues. And the answer is because the institutions want it all. So it’s interesting how there are companies trying to address retail access for these products, and essentially, sort of aggregating these orders so that retail customers, instead of being 250 different orders become one big order. All of a sudden, they’re taking them seriously.
You touched on regulations so let’s just end by talking about bond scams. They’re big at the moment because there’s some confusion by what an investment bond is and what a savings bond is. You’ve got a lot of people searching on Google for best interest rates, and a lot of people are being hoodwinked into the sort of ugly term of mini bond, which is not a regulated product. So do you want to just give us some quick tips on if you’re looking for a bond on Google, what should be the red flags? What should you be mindful of?
Well, first of all, an investor should know what he’s looking to get exposure to. Do you want to invest your money as savings and get a rate of return on that, or are you looking to take investment risk and generate a higher return than what you would expect from a savings account? If you’re looking for a savings product, it’s best to stick with fixed rate bonds issued by banks. So you’ve got NatWest, you’ve got Santander and lots of other banks, you know, who are regulated institutions as a bank. And so the first thing is, you know, if someone’s offering you a savings bond or calling it a savings bond and they’re not a bank, then it’s likely a scam, so avoid. If you’re looking for investment risk, there are different varieties, as we’ve talked about. Obviously, you know, the most common variety are listed bonds, which are bonds which have an ISIN, are listed on an exchange. May not be traded but at least listed, which means that there’s a certain level of regulation around that listing, you know, has been vetted by auditors, by regulators before it’s been listed. That gives you comfort that these are real investment bonds, structured appropriately and properly. And those are typically issued by your FTSE250, FTSE350 companies. So those are the types of bond that we have on WiseAlpha.
What’s the minimum market cap you look at, sorry, on WiseAlpha?
So most of the bond issues that we have are FTSE250 to FTSE350. There’s the occasional mid-size corporate but has a listed bond, which is on there, but most of them are billion value in size.
So if you’re investing in a bond, you should look at who’s issuing that bond. Is it a very big corporate that’s issuing that bond? Is there financial transparency? Are there investor reports, accounts, you know, things that you can assess the risk of that bond, the cash flows of the company? And that’s really what people should be focusing on.
And then you have this other variety, which are unlisted mini bonds, which have been a hot source of discussion and topic in recent weeks. These are bonds issued by very small companies. And, you know, they may or may not be sound, as an investment, but you know, you really need to do a lot of due diligence in assessing what the risk is with that bond. What is the company doing with that bond? Is it using it to fund its operations or is it using it to put it in their back pocket, which you obviously don’t want?
I mean there’s nothing wrong with high-risk investments, and high-risk investments and speculation make up a huge percentage of the market, but you just have to be mindful.
Be careful for these kind of unlisted mini bonds, because obviously, they tend to be issued by SMEs, which are higher risk, and so you may not be being compensated for the reward. And that area’s very murky because some people have been marketing them as savings bonds, which as I said, if you’re looking to have no risk with your money, you know, put your money in a bank, a regulated bank.
And of course, you get your FSCS protection on that as well.
And you get the FSCS protection, you know, deposit-based protection insurance. Everyone receives £85,000 worth of coverage. You know, for every bank you put your money in, up to £85,000. So you’re better off if you’re looking for a savings product, stick with banks.
But having said that though, you will be earning interest at a lower rate than inflation.
That’s true. But then you have to decide if you want to take real risk then you know that your capital is there.
And we should say actually as well, because you are a marketplace and not a bank, do your customers have FSCS coverage at the moment?
So our customers do not have FSCS coverage because we’re focused on investments, not deposit-protected savings accounts or saving products. Where the FSCS does come into effect for investment companies and we’re also a regulated company, it’s where there has been a failing of the company in providing this service or the regulated activity that it’s conducting. So any investment firm, if they mis-sell a product, you know, that could be caught under the FSCS. So if you’re a customer and you’ve been mis-sold a product, then you can potentially receive some compensation.
Great. So people buying bonds, if they want to come to WiseAlpha and have a go, what’s the process?
Very simple. Like most of the online investment platforms these days, you spend a few minutes filling your information in, answering some questions. We have a slightly higher part with WiseAlpha; we ask that you know a little bit about bonds before we let you loose on the market. But it only takes a few minutes and then you can deposit your money into your account, just like you would a stockbroker, and then you can buy bonds from the market and build your portfolio.
And top tips on learning more about the bond market; have you got any sort of internal and external resources?
Well, we like our customers to understand what they’re doing, so we have a lot of education on our site. So for customers who are interested in learning all the details and the mechanics of a bond and getting to the same level of experience as an investment fund manager, you can use our online bond academy, which is available on our site in our learn section. We write blog topics, a bit like I’m talking to you about the bond market now, for our readers to understand specific issues. So we’re very keen that people understand what they’re doing, because bonds have been a really misunderstood asset class, and actually, they’ve generated the best return over the last 20 years for UK investors, you know, versus other major asset classes like equities. So it has to be a major portion of your portfolio, in our view.
Great. Well Rezaah, thank you very much for coming in. It’s always a pleasure to see you. Thank you very much for watching this episode of Good Money Guide TV. We’ll be back talking about another asset class shortly.
Richard founded the Good Money Guide (previously Good Broker Guide) in 2015 and has been a broker for 20 years most recently at Investors Intelligence and previously a multi-asset derivatives broker at MF Global (Man Financial). Richard started his career working as a private client stockbroker at Walker Crips and Phillip Securities (now King and Shaxson) after interning on the NYMEX oil trading floor in New York and London IPE in 2001 & 2000.