Corporate bonds - how much risk?

thegentleway

Hi,

I'm looking at corporate bonds secured by assets, with additional Risk Mitigation, e.g. Lloyds of London insurance, since they offer good returns. They come with disclaimers saying they should be consider highered risk investment. Could somebody explain how much risk is involved?

Thank you

HappyHarry

thegentleway wrote: »

Hi,

I'm looking at corporate bonds secured by assets, with additional Risk Mitigation, e.g. Lloyds of London insurance, since they offer good returns. They come with disclaimers saying they should be consider highered risk investment. Could somebody explain how much risk is involved?

Thank you

They will vary between incredibly secure (triple A rated) and very high risk, (some junk bonds). It depends what exactly you are looking at.

If you are looking at "mini-bonds", then these tend to be of a higher risk nature.

If you could let us know which corporate bond you are looking at, you will probably receive more pertinent answers.

bowlhead99

thegentleway wrote: »

Hi,

I'm looking at corporate bonds secured by assets, with additional Risk Mitigation, e.g. Lloyds of London insurance, since they offer good returns. They come with disclaimers saying they should be consider highered risk investment. Could somebody explain how much risk is involved?

Thank you

Generally you can read 'higher risk' as anything up to and including 'could lose all your money' but it is difficult to quantify how likely it is that happens if you are not an expert.

It would depend on the exact structure of the bond, who is issuing it, and what if any practical recourse to assets the bondholders really have and whether those assets on which it is secured now, continue to exist.

Lloyd's themselves issued 10 year redeemable subordinated debt last year with a yield that was 3.3% higher than Treasury 10 year gilts at the time. The extra reward is there for the extra risk - it's not as safe as lending to the government through gilts. They can defer the interest if paying it would breach their regulatory capital requirements. And that particular issue was only tier 2 rather than tier 1.

If you are not investing in bonds issued by Lloyds themselves but just some private bond raised by a company who's going to participate as a Lloyds member, the risks could differ. There are probably some scams around if you are buying a privately isssued bond rather than something highly liquid on the bond market.

Bond pricing (and therefore the effective yield you get from it when you buy a bond at a certain price) depends on the perceived creditworthiness of the borrower in the market and can change over time as market interest rates change too. So unless both (a) you hold to maturity rather than selling out to someone else early, and (b) the borrower is still solvent to be able to pay you out at maturity, you might get back less than you paid.

Linton

The risk of investing in funds of shares is that you, probably temporarily, lose part of their value. The risk with individual loans, which is what corporate bonds are, is that you lose everything. The probability of this happening depends on the company issuing the bond. Some are very well established household names, others are start-ups wanting cash to invest in who knows what. A few are scams.


Any company needing to provide additional insurance based risk mitigation in addition to the documented strength of the company cannot be that safe. Then you have the possibility should this risk mitigation ever be called upon, the insurer goes bust. This has happened in the past.


Assets held by unknown companies are not necessarily that much of a reassurance. For example, one bond I checked up on was covered by a large Victorian mansion in the middle of nowhere apparently used as a children's home.


These bonds often seem to be marketted to naive investors who are led to believe they are investing in something like a bank fixed term deposit. This type of corporate bond is very different and at most should only form a small part of an experienced investors portfolio who can afford to take the risk.

dunstonh

if you have a typical 1-10 scale for unit linked funds then corp bond funds can be found in 3-10. i.e. across the scale. If you are talking individual corp bonds then you are above that typical 1-10 scale in isolation.

So, you really need to clarify what type of corp bonds you are talking about

kidmugsy

Common advice is that you reduce default risk (and avoid sundry complications) by eschewing individual bonds and buying a bond fund. That, however, means giving up the essential nature of a bond.

Heedtheadvice

Must make a note to the above respected posters that it might be useful to explain some of the terminology used in your posts. I am not being critical or disagree with what you write but it might help the OP!


It is likely that someone asking for basic advice might not be used to terms such as "tier 1", "the essential nature", "subordinated debt" etc. and whenever dealing with risk to scope what thise risks are as you will appreciate there are many different risks.


For the OP I strongly agree that with indvidual bonds if the risk ( of large capital losses) is to be reduced then, if you do not have sufficient funds to be well diversified within your own investments and acceptable risk profile, the best course of action is to invest in collective funds.


Risk mitigation (as has already been pointed out) by relying on advertised insurance or underlying assets associated with bonds can become problematic should the risk actually materialise - especially if these become worthless too!

dunstonh

Must make a note to the above respected posters that it might be useful to explain some of the terminology used in your posts. I am not being critical or disagree with what you write but it might help the OP!

If the OP does not understand the terminology used then they are not ready to invest that way. What the OP is considering is a more advanced method of investing. So, you shouldnt move onto that level until you are ready. Not knowing probably acts as a good indicator to not doing it.

bostonerimus

kidmugsy wrote: »

Common advice is that you reduce default risk (and avoid sundry complications) by eschewing individual bonds and buying a bond fund. That, however, means giving up the essential nature of a bond.

Yes the issue with bond funds is that you can't exactly hold to maturity and get your original capital back, but you can reinvest interest and hold for times longer than the average maturity of the fund and that should smooth out the effects of price variations. FYI there is an interesting product in the US called the Define Maturity bond Fund which holds bonds that all mature at the same time so you get the risk mitigation characteristics of a bond fund and can hold to maturity like an individual bond.