The next scandal brewing - retail bonds

dunstonh

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.

Investment funds dont do that unless they are are specialist investments.

Do any of these apply to the retail bonds?

These bonds are not retail products. They are not aimed at the retail consumer market. They shouldnt be considered in the same way as retail financial products.

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

in isolation on a 1-10 scale, probably around 10 in many cases as you have 100% loss of capital potential and no FSCS protection.

bigadaj

dunstonh wrote: »

These bonds are not retail products. They are not aimed at the retail consumer market. They shouldnt be considered in the same way as retail financial products.

But the point here is that they are being advertised direct to consumers and are effectively targeting naive consumers in many cases.

There's no consumer protection in place but it'll be interesting to see the fall out when the first of these goes pop, it could be a death knell for the papers that have taken the advertising in the first place.

pqrdef

Not just Sunday papers. I'm also getting a lot of targeted Google ads. I don't know what I've Googled to be targeted.

jimjames

pqrdef wrote: »

Not just Sunday papers. I'm also getting a lot of targeted Google ads. I don't know what I've Googled to be targeted.

It's not necessarily anything you've googled. It could be any website you've visited so even MSE could trigger it.

Nice_Weather_For_Ducks

ForestThoughts wrote: »

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.

Not something that the banks offer to their customers, so it cant be mis-sold, unlike every other product that banks do offer and yet manage to mis-sell LOL

spacey2012

China, Russia, the USA, Germany are all bailing in to Gold at an alarming rate.
The UK sold most of it's stocks at what has become know internationally as Browns Bottom.
The UK has lots of bonds, bits of paper, debt notes, guaranteed against future interest payments.

You dont have to be a financial genius to work out what is going to happen when the bonds bubble goes pop.

ChesterDog

Are they? So why is the price still so depressed?

With so much of UK gilts now the (theoretically temporary) property of the BoE, is it at all clear what will happen when QE falls off and the values drop? The BoE will be sitting on a loss, but as it bought them with invented money in the first place, how much will that matter?

IronWolf

spacey2012 wrote: »

China, Russia, the USA, Germany are all bailing in to Gold at an alarming rate.
The UK sold most of it's stocks at what has become know internationally as Browns Bottom.
The UK has lots of bonds, bits of paper, debt notes, guaranteed against future interest payments.

You dont have to be a financial genius to work out what is going to happen when the bonds bubble goes pop.

I'm not sure what your point is. The UK, like all governments, issues debt, which is currently cheap due to low central bank interest rates and QE. Once it all unwinds interest rates will return to a more normal rate but all that affects is the cost of the UKs refinancing.

ChesterDog

spacey2012 wrote: »

China, Russia, the USA, Germany are all bailing in to Gold at an alarming rate.
The UK sold most of it's stocks at what has become know internationally as Browns Bottom.
The UK has lots of bonds, bits of paper, debt notes, guaranteed against future interest payments.

You dont have to be a financial genius to work out what is going to happen when the bonds bubble goes pop.

Speaking as a non-financial-genius (that means I am not a financial genius, not that I am a genius but not at financials), I have become less convinced over time that there is a bond bubble about to pop, more that the prices are simply somewhat elevated. If there is a bubble, it would only pop if the BoE triggered it by selling a large tranche of its recenetly bought bonds. Why would it do that, to sell at a horrible loss? More likely, as QE is very gently unwound, bond prices will fall. A bit. Until the yields are more normal.

It must be obvious to everyone and his dog (ahem) that markets and the wider economy are very nervous about the ending of QE and therefore it must be done very gently and over a long, long timescale to avoid causing damage. Does anyone seriously envisage it being done with a jolt, wrecking the recovery, decimating markets, puncturing bubbles..?

ChesterDog

It's fortunate that QE and its management are BoE and not government policy, so whoever gets elected next won't be able to scupper at least that aspect of the recovery.