The next scandal brewing - retail bonds

ForestThoughts

Am sure someone else has done this before, but you cannot help but feel a growing sense of unease over the number of retail bonds being issued by lower rated credits to 'Joe Public' or for all those 1980's BG aficionados - 'Sid'.

If Tesco PLC (to choose a FTSE 100 stock at random and not as a buying suggestion!!!) decides to give retail investors the opportunity to get a premium over the paltry savings rates offered by the UK banks and building societies we can happily find out what an independent party thinks of the credit rating. Formal agencies like S&P, Moodys and Fitch may have their issues, but they are staffed by people who generally know what they are doing (I chose my words carefully).

Now we come to those marvellous adverts in the Sunday papers offering 7.5% or 6.5% yields on their bonds with various talks of 'the guarantees you would want'. I am not quite sure how we have got ourselves into a regulatory situation where they can get away with being able to solicit funds this way, but if regulators were perfect then we would not have been in the last banking mess either (LIBOR fixing, exotic swaps to councils or indeed SMEs, being sold insurance you couldn't claim on anyway, CLO's of subprime mortgages).

The issue is not whether the deal is a good one or not, but appropriateness for the investor class.

FOUR thoughts as to why these may not be as good as they looked for inclusion in Sid's £100,000 savings and investment portfolio:

• Liquidity -

In plain English if you wanted to sell them, could you and if so at what price? The Tesco bond should be freely tradable and have a relatively narrow 'bid offer' spread (selling and buying price to the uninitiated).

• Credit rating -

The bond may well be unrated. This does not in itself mean it is a bad credit, but if you wanted to raise a serious amount of money perhaps you would go to the expense of getting a rating? Unless of course it would look poor, next to its rivals on the page.

• Start-up or high development risk -

Tesco may be looking to raise money to redeem existing debt, but it is unlikely in a retail bond to be doing something so large (i.e. risky) that would impact its overall senior debt rating.
Are the people who are offering you 7% unable to raise money from anyone else? Do you really want to be the lender of last resort?

• Asset backing -

What is it worth exactly? Has a third party appraised it and does it have a second hand value.

Sadly the value of an asset in a 'going concern' can be very different from that of a failed business. Risk appraisers will try and look at the range of values that might apply in a given situation (like when you buy a house and a valuer may provide an open market as well as a forced sale valuation).

An ENTIRELY MADE-UP example -

I have a new start up called 'MyBigWind' and need £15m to get it off the ground. I have some equity to cover the expenses of the fund raising, but decide to raise money via a bond issue. My strategy is to build a small wind farm in the middle of the Atlantic Ocean (half way to America and UK and thus geographically diversified with two potential markets).

Sadly nobody wants to buy my power as my project costs (predominantly funded via a 10 year bond offered at an initial attractive 8% yield) mean that I can only sell at a premium to the market.

So, what are those assets worth if my business defaults as I cannot pay the interest:

• The price I paid to get the turbines out there, installed and built the infrastructure to get the power back to the UK and the US?
• Not a lot

You guessed it........

Now I am sure there are good retail bonds out there. But when the rest of the UK financial services regulation appears to be designed to cover any retail investor in cotton wool, have they fallen asleep at the wheel again?

I suggest that these products are for sophisticated investors only and you should not be able to advertise them alongside national savings in a Sunday paper!

Finally, in the dash for returns, remember that all bond prices (retail, corporate, hi-yield) have an inverse relationship with interest rates. So when the markets finally decide that longer term UK Gilt yields should rise (and the Bank of England gives up throwing money at the bond market via Quantitative Easing), then bond prices will fall.

Bonds with longer to final maturity will fall more than shorter term bonds as the impact of the interest rise has longer to erode the value of your fixed semi-annual coupons.

Probably the main saving grace of buying bonds direct is that at least if you hold it to maturity, you will get exactly the return it 'said on the can' when you bought it. Namely the yield to maturity. Provided of course it does not default and there in lies the potential issue for Sid and his portfolio.

Borrowers only offer high rates for a reason, which is to be attractive enough for someone to be willing to take the risk of investing in them. They are not doing so because they want to give the reader and potential investor a free 'Sunday' lunch.

opinions4u

Feel better for that?

jimjames

Nothing that hasn't been said here when someone posts a question about retail bonds.

There is an element of buyer beware but as the Royal Mail IPO showed many people are more bothered about making a quick buck than reading what they are buying.

ForestThoughts

How about filling in potholes as a social good. Sadly all you get is a complaint from the council for meddling in their affairs.

jimjames

ForestThoughts wrote: »

How about filling in potholes as a social good. Sadly all you get is a complaint from the council for meddling in their affairs.

You've posted valid advice but the people it is directed at are generally not interested in reading why they shouldn't invest.

ForestThoughts

'My lord, I have a cunning plan':


Find a legal way to short the dodgiest looking retail bond in the Sunday Telegraph, make sure you have enough liquidity to survive its undoubtedly short longevity and hey presto.

dunstonh

The next scandal brewing - retail bonds

It wont be a scandal as these are bought by people on a DIY basis.

I suggest that these products are for sophisticated investors only and you should not be able to advertise them alongside national savings in a Sunday paper!

They are not retail products. However, you are right, they are not normally aimed at the average retail consumer but some have started to do that and there will be people that are caught out.

JuicyJesus

One would suggest the OP's complaint lies with the Sunday papers who accept money to advertise these bonds.

kidmugsy

ForestThoughts wrote: »

If Tesco PLC (to choose a FTSE 100 stock at random and not as a buying suggestion!!!) decides to give retail investors the opportunity to get a premium over the paltry savings rates

1) Beware! The last bonds I saw from Tesco weren't from Tesco PLC but from Tesco Bank.

2) A fool and his money ….. There is no end to the possibility of more regulation and there is no end to the stupidity and gullibility with which people with more money than sense will contrive to fleece themselves. Meantime the regulations force up the costs, and diminish the choices, of everyone else. I have no general solution to offer to these problems. Except, of course, arresting as many financial crooks as possible and hanging them in public.

jimjames

ForestThoughts wrote: »

The issue is not whether the deal is a good one or not, but appropriateness for the investor class.

I'd suggest that as these investments are made out of choice that far from being a mis-selling scandal it is actually mis-buying. If people want to purchase these bonds without reading what the risks are then there isn't much we can do to stop them. It doesn't help that banks use the word "bond" for a savings account but the risk warnings I've seen have been pretty clear.

Ironically for many of the people buying such bonds that do so because they want to avoid the risks of the stock market they may actually be less risky buying a S&S ISA with investments instead.

Porcupine

Question: when you buy any kind of investment from the usual fund houses they're full of warnings that they're only for sophisticated investors, may eat your grandchildren or whatever. Do any of these apply to the retail bonds? When you buy a retail bond are you forced to agree to warnings that you may lose your investment, they're inherently more risky than some other investments, and so on? Because if not that would seem not to be a level playing field.

Are retail bonds risk-graded on the usual 1-7 scale (where equity always seems to be 6). Where do they fall?