Individual corporate bonds vs bond fund

assetallocator

So I understand that holding individual gilts to maturity could be considered lower risk than investing in a gilt fund, because the returns are fixed and the return of the principal is virtually guaranteed, but that is not true of individual corporate bonds, because there is a risk of default. I'm struggling to understand how to weigh up the risk of holding a ladder of corporate bonds yielding 5-8%, vs a fund with an equivalent yield. Are there statistics about bonds that have gone into default and what sort of losses were suffered by the bond holders? A bond fund might have over 100 holdings, but what sort of number would be needed to have enough diversification? Is it even practical to pick your own bonds without taking on too much default risk to make it worthwhile?

chucknorris

assetallocator said:

So I understand that holding individual gilts to maturity could be considered lower risk than investing in a gilt fund, because the returns are fixed and the return of the principal is virtually guaranteed, but that is not true of individual corporate bonds, because there is a risk of default. I'm struggling to understand how to weigh up the risk of holding a ladder of corporate bonds yielding 5-8%, vs a fund with an equivalent yield. Are there statistics about bonds that have gone into default and what sort of losses were suffered by the bond holders? A bond fund might have over 100 holdings, but what sort of number would be needed to have enough diversification? Is it even practical to pick your own bonds without taking on too much default risk to make it worthwhile?

I would prefer individual corporate bonds but I have struggled to find reasonable ones giving a decent return, but saying that I only use HL, and there might be better platforms to use, does anyone know any?

At the rates you are looking for you would be taking on significant risk, but I have done it with Wasps (that looked very hairy for  a while, I invested at an average price of 59 pence, and that gave a return of 11%, it's spread now is about 86.5 to 90 pence, so although much better not completely safe. I also invested in Burford (6.5% and 6.125%), Provident financial (5.125%, 6% and 7%) and Lendinvest 5.25%. But I'm not sure that I would do it again, I bought the others (not wasps) in the mid 90 pence range, so the running yield was quite good, it was a bit risky though, but they all made it to maturity (one Burford one matured early) and I now only have Lendinvest and Wasps who I hope will mature next year (August and May), I am prepared for the Wasps bond being redeemed at under 100 pence(but very likely much more than I invested at). But of course some investors bought at 100 pence and above!

assetallocator

Thanks, that's useful. I've been looking at sites like fixedincomeinvestor.co.uk and as you say there aren't a lot of options. I do worry that without spreading my money around a good number of bonds the impact of a single one going bad could take a long time to recover from. That's why I was wondering what sort of real world losses are suffered when something like that happens. Hopefully not 100% like shareholders experience when a company goes bust. It's hard to make a judgement without understanding that side of things.

You mentioned some uncertainty about Wasps redeeming at a known value. It looks like it was issued at 100p, so I suppose investors are expecting it to redeem at 100p and they'd have to default on that in order to give back investors less? Sorry for the stupid question, I just wanted to be clear that was what you were saying.

chucknorris

assetallocator said:

Thanks, that's useful. I've been looking at sites like fixedincomeinvestor.co.uk and as you say there aren't a lot of options. I do worry that without spreading my money around a good number of bonds the impact of a single one going bad could take a long time to recover from. That's why I was wondering what sort of real world losses are suffered when something like that happens. Hopefully not 100% like shareholders experience when a company goes bust. It's hard to make a judgement without understanding that side of things.

You mentioned some uncertainty about Wasps redeeming at a known value. It looks like it was issued at 100p, so I suppose investors are expecting it to redeem at 100p and they'd have to default on that in order to give back investors less? Sorry for the stupid question, I just wanted to be clear that was what you were saying.

Wasps were (you could say that they still are) in trouble financially and of course Covid didn't help as they lost fixtures with attendances. It still isn't clear how they will refinance the bond next year in May, their stadium is a charge on the bond debt, it is (on paper) worth about £52m and the bond debt is £35m, but if it went that way, it would be messy and also take time, and in this Covid climate there might not be a lot of interest in the stadium. But the bond has risen from a low of 35 to 38 pence to 86.5 to 90 pence, if you look at some graphs the low appears as about 26 pence, but that was never available, I tried to buy £40k, £30k, £20k, £10k and even just £5k at that price but nothing was available, so it must have been just a tiny amount.

I took a very cavalier attitude because they were a sports business (team), I know some football clubs like Bury have gone under, but usually they survive quite a long time in trouble before they eventually go under, so I decided to take a chance with them. I knew that it was risky, but I have received about 10% interest over 3 years and also I am hoping for a decent capital gains tax free windfall when the bond is redeemed. I don't think that I would take on risk like this again though.

Thrugelmir

assetallocator said:

That's why I was wondering what sort of real world losses are suffered when something like that happens. Hopefully not 100% like shareholders experience when a company goes bust. It's hard to make a judgement without understanding that side of things.

Risk is priced. In a low yield enviroment the premium you receive is to cover potential 100% losses. Bond holders rank well down the list of creditors when a company goes bust and any remaining assets are realised and distributed. 

wmb194

If you're going to invest in individual bonds you really need to try to understand the company's business and prospects, look at its financials and what people are saying about it - much easier with listed companies like Provident Financial - and the bond's prospectus e.g., to see things like where they rank - senior, unsecured, subordinate etc. - what security theres is and so forth. 

I stayed away from Wasps when it issued as it looked like a loss making, weak company dependent on a single rich benefactor, rugby isn't known for making much money and the value of its security (the stadium) is quite speculative.

Historically recovery rates on corporate bonds are/were about 40% but it really depends on the type of company.

6 to 8% in the current environment is more like investing in equity and at the retail level you'll have a hard time building a diversified portfolio.

Btw, if you're really interested, there are also irredeemable preference shares listed in London yielding c.6% e.g., Aviva/General Accident, Lloyds Bank, Royal Sun Alliance, Santander, Ecclesiastical Insurance, BP and a few others. I think they're also listed somewhere on the website you've been looking at. These are exceptionally long dated, i.e. in theory never, though, and you can expect them to react poorly to high inflation if that comes about.

chucknorris

wmb194 said:

I stayed away from Wasps when it issued as it looked like a loss making, weak company dependent on a single rich benefactor, rugby isn't known for making much money and the value of its security (the stadium) is quite speculative.

So did I, but I thought that they were exceptional value when the price became more realistic. I invested at an average price of 59 pence, which gave an overall interest return of about 10% (I started investing at about 85 pence) and a potential tax free capital gains windfall, well worth the risk I thought at the time, and I still do (but maybe not so much at the current price).

But it was far from an easy ride, and I don't think that I would do it again. I am trying hard to change and be defensive of my wealth and accept lower returns, but it doesn't come easy (but I know that I need to do it).

wmb194

chucknorris said:

wmb194 said:

I stayed away from Wasps when it issued as it looked like a loss making, weak company dependent on a single rich benefactor, rugby isn't known for making much money and the value of its security (the stadium) is quite speculative.

So did I, but I thought that they were exceptional value when the price became more realistic. I invested at an average price of 59 pence, which gave an overall interest return of about 10% (I started investing at about 85 pence) and a potential tax free capital gains windfall, well worthy the risk I thought at the time, and I still do (but maybe not at the current price).

Yes, I know, I read your previous posts. but it's still a speculative investment in a weak company. Take a look at its most recent accounts: https://find-and-update.company-information.service.gov.uk/company/04187289/filing-history

I'm not saying you shouldn't invest in these sorts of things just that at these yields in this low yield environment you're not talking low risk and you need to know what you're getting into. The advantage of using a fund in this area is that the professional fund managers are often better at navigating the minefield.

assetallocator

wmb194 said:

The advantage of using a fund in this area is that the professional fund managers are often better at navigating the minefield.

Yes, I can see the logic in that. There are more risks to consider than with government bonds. What rather puts me off a fund is that you have to buy the whole portfolio at its current market price and if you are planning to gradually draw down capital, you need to sell at an unknown future market price, unlike buying a ladder of individual bonds which will mature over time.

I've read somewhere that holding an index fund over its duration is equivalent to holding the average bond holdings to maturity, but to be honest I've never been able to get my head around that. An index fund wouldn't give you the manager insight, of course, and I wasn't considering buying a HYB index fund.

masonic

If your holding period is long enough these things ought to even out. Corporates aren't really suitable for short-term investing. An active manager will buy bonds when they are good value and hopefully sell them when they are overvalued, so the portfolio as a whole should be about as attractive as anything you could put together yourself. It may contain things you cannot access. I'd echo others' comments about the risk you'd be taking on for these returns.

Thrugelmir

assetallocator said:

wmb194 said:

The advantage of using a fund in this area is that the professional fund managers are often better at navigating the minefield.

unlike buying a ladder of individual bonds which will mature over time.

Liquidity is extremely low in many bond stocks. In addition you may struggle to trade in small quantities. Market makers that service retail platforms are unlikely to be any holding stock.