Corporate Bonds

Nazitf

I'm pretty new to investing in unit trusts and just wanted a bit of advice.
I would class myself as a very cautious investor and at the moment I only want to invest using my ISA allowance. I wish to invest in investment grade corporate bonds and assuming the fund consists mainly of high quality bonds, I plan to simply select the one which returns the highest yield.

Apparently the highest paying funds are more likely to see a drop in capital value however I don't really understand why this would happen if the fund invests mainly in AA / A rated bonds.

In the past I have bought funds using the BestInvest website. My choice was based upon the gross yield (obtained for other sites) and the TER. The info pack that came from BestInvest states that the site earns a 'trail commission' of up to 0.5% per annum. Should I be adding this to the TER when researching different funds?

Rollinghome

Nazitf wrote: »

I'm pretty new to investing in unit trusts and just wanted a bit of advice.
I would class myself as a very cautious investor and at the moment I only want to invest using my ISA allowance. I wish to invest in investment grade corporate bonds and assuming the fund consists mainly of high quality bonds, I plan to simply select the one which returns the highest yield.

Apparently the highest paying funds are more likely to see a drop in capital value however I don't really understand why this would happen if the fund invests mainly in AA / A rated bonds.

In the past I have bought funds using the BestInvest website. My choice was based upon the gross yield (obtained for other sites) and the TER. The info pack that came from BestInvest states that the site earns a 'trail commission' of up to 0.5% per annum. Should I be adding this to the TER when researching different funds?

The capital value of bonds moves up and down in the opposite direction to other available interest rates. So if you have a £100 bond (an IOU) that pays 10% interest it will now be worth much more than £100 to someone because 10% is above current rates. If rates rose to 11%, or were expected to, then it would be worth less than £100. The life of the bond also effects its value, 10% for 2 years is worth more than 10% for 1 year, as does the financial state of the issuer. If you pay £150 for a £100 bond at 10% you'll get the benefit of the high interest but will only get back the original £100 at maturity, so you'll have lost capital.

The trail commission and most other costs are included in the TER (Total Expenses Ratio).

jamesd

The highest paying bond funds don't invest mainly in high grade bonds.

There has been something of a bubble recently in the prices of the highest grade gilt (UK government) and UK corporate bond funds and I think it's worth avoiding funds using mostly those and using bonds from the strategic bond sector at the moment. That way the increase in yields/decrease in capital value as the effects of quantitative easing end work through the system will not affect you so much.

In between high grade bonds and the very highest paying funds there's a middle ground paying 6-9%.

Nazitf

Rollinghome wrote: »

The capital value of bonds moves up and down in the opposite direction to other available interest rates. So if you have a £100 bond (an IOU) that pays 10% interest it will now be worth much more than £100 to someone because 10% is above current rates. If rates rose to 11%, or were expected to, then it would be worth less than £100.

If I’ve understood you correctly, the capital value will decrease as the Bank of England interest rates increase since the individual bonds become less attractive to others. So does that mean one should check the rates of each individual bond within the fund to ensure that they are sufficiently high enough?

Rollinghome wrote: »

If you pay £150 for a £100 bond at 10% you'll get the benefit of the high interest but will only get back the original £100 at maturity, so you'll have lost capital.

How can you tell if you're paying more for a bond than its actual value? By choosing to invest in corporate bonds I was hoping that the volatility would be low so as not to have to worry too much about a potential loss of capital.

tramoia

The idea of investing in a corporate bond fund rather than in individual corporate bonds is partly that you are paying the fund manager to work out the best strategy and sets of bonds for optimal returns. So i don't think you should worry too much about the constituents of the funds. What might be more useful, apart from the TER, is to check how the fund has perfomed against its peer group of funds in terms of total return, yield, and capital preservation. Analysis sites such as Lipper Leaders will enable you to compare several bond funds side by side for those sorts of details.

The mention of strategic bond funds by another poster is interesting. These have a range of kinds of strategy, with some looking far riskier than others. Again you might want to do some homework to help you fit the fund to your risk profile.

baby_boomer

Any fixed rate bond - secure or not - would drop in value if inflation really took off.

Annisele

Depending on what you mean when you describe yourself as a "very cautious investor", you might not want to invest in corporate bonds at all.

Halifax's corporate bond fund, for example, fell about 17% Q4 2007 to Q4 2008 (but admittedly then pretty much bounced right back). That fund describes its policy as "to invest in a wide rate of investment grade interest-bearing securities" - it does have a bit of BB and below in it, but not much.

Halifax's gilt and fixed interest fund grew about 10% Q4 2007 to Q2008 - but then fell 3% the next year.

It's possible for the price of corporate bonds (even investment grade corporate bonds) to collapse. Are you happy with that risk?

Unless you are a higher rate taxpayer, the tax benefits of holding corporate bonds within an ISA aren't all that exciting.

(I'm not saying that Halifax are either particularly bad or particularly good, I'm just using their funds as examples).

cogito

Every corporate bond fund fell considerably around 18 months ago in the general market panic. It was ridiculously overdone and bonds were an absolute bargain given the yields. A lot of people myself included were happy to buy bond funds at this point and many funds are now up by an unheard of 20%+ since then.

StevieJ

cogito wrote: »

Every corporate bond fund fell considerably around 18 months ago in the general market panic. It was ridiculously overdone and bonds were an absolute bargain given the yields. A lot of people myself included were happy to buy bond funds at this point and many funds are now up by an unheard of 20%+ since then.

That was due to the threat of default the obvious threat in the future is the increase in interest rates, I will not be buying bonds in the future although I will hold my position for now in the Invesco Perp monthly income plus BTW that must be up 40% (it does have a 20% equity position) .

DiggerUK

Nazitf,
I see corporate bonds (CB's) as a bad investment. As dangerous a risk as Icelandic banks turned out to be. A simple smell test should have told anybody that the rates being offered by the Icelandic banks, was too good to be true.
If it wasn't for the government bailout, many on these boards would have seen a good part of their investments go belly up.

With the complete tanking of interest rates for savers, there are a lot of people preparing to take a high risk for a better return in the CB market with their savings.
CB's, (plus government gilts/treasuries) can now be purchased through London Stock Exchange traders like any other share can be bought.
Individuals being able to purchase CB's is a recent phenomenon, I say it's because the banks will not lend to what they see as risky customers. A simple smell test should warn people, that when banks won't lend, it is probably down to the banks viewing them as a bad risk.

Most are paying 7% plus. In funds with a spread, they are realising about 4% plus. As the CB's are normally fixed rate, and fixed term, you will get stiffed if inflation kicks of over 5/6%, An inflation rate that is likely given the ammount of funnies from the printy printy factory.
Unlike cash savings if you cash in under those conditions you will not get your initial investment back.

And unlike the Icelandic bank fiasco you will not get bailed out. Buying CB's, Gilts, and Treasuries, that are not index linked, is a one way ticket to Palookaville. Even index linked are relying on the corporation not going belly up.
It is less than 3 years since queues outside Northern Rock, the real fun is still to come. Seems to me like short term memory loss is the problem for many round here.

StevieJ

DiggerUK wrote: »

Nazitf,
I see corporate bonds (CB's) as a bad investment. As dangerous a risk as Icelandic banks turned out to be. A simple smell test should have told anybody that the rates being offered by the Icelandic banks, was too good to be true.
If it wasn't for the government bailout, many on these boards would have seen a good part of their investments go belly up.

.

I withdrew my money from Icesave a couple of weeks before they went belly up, due to the CDS rates shooting up