Corporate bonds - a good time to invest?Posted on: 17 April 2012 by Robert Haymes
With Bank of England interest rates remaining at a record low, Robert Haymes examines the value of investing in corporate bonds.
Do corporate bonds offer good investment opportunity? In short, there's no simple answer to this. As with many things, it depends on your circumstances and what you want from your investments.
Your best starting point with corporate bonds is to speak to a good independent financial adviser, who will be able to talk through all your options and make recommendations based on this. What we can do here is give you an overview of corporate bonds, along with their benefits, possible drawbacks and how to reduce your risks if you invest in them.
First, we'll clear up a misconception we come across regularly. It's often thought that investing in corporate bonds means you are investing in equities. This isn't the case. Equities are shares in companies, meaning you effectively own a small 'slice' of a company.
In contrast, a corporate bond is effectively a loan from you to a company over a set term. In exchange for you lending money to it, the company pays you a 'coupon' (a regular payment of interest fixed at the outset also known as the yield) over the term of the loan, and repays your original amount at the end of the term.
The yield on them is not linked to the FTSE100, neither are they affected by fluctuations in the Bank of England base rate or movements in the equity markets. The main driver behind the yield you get is the company's ability to repay.
However, the sale price of the bonds can be driven by market forces, and the price may go up or down if people decide they want to hold onto bonds from a particular company, or offload them.
Why might now be a good time to buy corporate bonds?
An interest rate of 4.5%- 5% would not be unusual at the moment on an investment in a low to medium risk corporate bond fund, which is attractive when compared to the current Bank of England rate of interest of 0.5%. Bear in mind though that should interest rates rise over the next few years, this rate may not seem quite so appealing.
How can you reduce risk when investing in corporate bonds?
You can reduce risks by investing in a corporate bond fund, meaning you'll be invested in a variety of corporations, either UK-based or international. A corporate bond fund buys a selection of different corporate bonds, thereby spreading your risk by being diverse. A typical bond fund will hold between 80 to 85 holdings spread across companies with a range of credit ratings.
Bonds (generally speaking) are less risky than equities and less volatile. They can be a useful way of gaining extra income over and above a bank or building society deposit account. Another attraction of this income is that it is a fixed amount of interest. For example, if a corporate bond's term is 10 years, then you will receive interest at the rate you bought the bond at for the 10 year period, providing that the company does not default on its payments during that period.
Corporate bonds can be divided into two categories: investment grade and non-investment grade. What grade a company is, is determined by their credit rating. This then determines the rate of interest that company will need to pay to attract investors' cash to raise the capital it needs, and also determines how much you receive on your investment.
More risky (less financially strong) companies yield a higher coupon as their perceived risk of default is higher. Investment grade bonds are issued by companies that are more likely to fulfil their obligation of paying you an income during the term and returning your original capital at maturity, therefore they offer a lower yield than riskier companies.
The value of shares and investments can go down as well as up.
Past performance is not a guide to future performance.
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