It has become almost accepted wisdom that “there is a bubble in the bond market”. But which bond market? I would say that lending money to the UK government for ten years in return for less than 2 per cent is a pretty lousy trade, but I’m not sure it’s a bubble. There isn’t going to be a “99 per cent” club for gilts as there was for dotcom stocks. You could say the same for many investment-grade corporate bonds.
Talk of a bubble in high yield is closer to the mark. Pundits have vied with each other to provide ever more shocking examples of frontier markets that can borrow for 10 years at sub-5 per cent yields: Bolivia and Rwanda are just two of the more recent. That may indeed be a bubble. Still, I doubt many UK investors are lying awake at night worrying about Bolivian government debt blowing a hole in their pensions.
Advisers have been badgering me for weeks about the London Stock Exchange’s order book for retail bonds (Orb), which allows individual investors to buy bonds in small denominations on a regulated market.
Credit quality isn’t what it was in the market’s early days, they grumble, when big banks and retailers were the main issuers. Many of the companies raising money there now are not even scored by credit rating agencies and some of the covenants are weak. They say retail investors, unversed in the finer technicalities of fixed income, are treating these as savings products and buying indiscriminately. Sooner or later, there’ll be a default and savers will realise these are not deposits and they’re not covered by the Financial Services Compensation Scheme. There’ll be tears at bedtime.
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It’s easy to dismiss such complaints as the diatribes of the disintermediated; advisers can’t stand it that investors are going direct, rather than taking their expensive advice and buying bond funds. But they have a point. A properly structured bond portfolio should resemble a “ladder” of maturities, with holdings spread across different sectors. But the stock selection process in this market, where each new issue is enthusiastically marketed by a cohort of retail stock brokers, is most likely: “Six per cent? I’ll have a bit of that thank you very much!”
The bonds listed on Orb have three big redeeming features, though. One is that in the main, you can put them into Isas (there must be five years or more to maturity at the point of purchase). Another is that you can get rid of them.
Granted, secondary market liquidity is pretty thin and the market has not been tested by a serious company crisis. But there is at least two-way pricing and you can sell anytime you want. Finally, companies have to adhere to a bit of due process before they can list. Because the securities are tradeable, issuers must submit a prospectus that conforms to the Prospectus Directive and is vetted by the UK Listing Authority.
I’m inherently mistrustful of any investment that doesn’t allow me to change my mind
– Jonathan Eley
That’s all in contrast to the so-called “mini-bond” market. These popular retail bonds are offered in small amounts direct to consumers by companies as diverse as John Lewis and King of Shaves. Capita, which acts as administrator for many of them, said this week that the market for these could be worth £1bn by the end of 2013 and £8bn by the end of 2017. A £15m mini-bond issue for the Jockey Club, widely advertised on London’s Tube network, closes this week – just in time for another, for health charity Nuffield, to open.
There is no secondary market in mini-bonds – investors are locked in for the duration of the loan. Because I’m prone to self-doubt and indecision, I’m inherently mistrustful of any investment that doesn’t allow me to change my mind. There is also little regulation of the issue process. There is no prospectus, just an offer document, and as a “financial promotion” it must only be “fair and not misleading” in the eyes of the (regulated) company promoting it. The potential for misunderstandings is fairly obvious. There has already been a failure in this market, albeit a small one: alternative lending company Frodo has gone into administration, and the interest on a £750,000 mini-bond is being paid from the capital raised while the administrator seeks a buyer.
None of this would matter too much if investors were being lavishly rewarded for the risks they are taking. But it’s hard to say they are. The Jockey Club issue trumpets a headline rate of 7.75 per cent, but 3 percentage points of this comes in the form of racing-related freebies, rather like the sports debentures of old. John Lewis pays part of its coupon in store vouchers. And after-tax interest rates will be lower still for many savers.
So there you have it – interest rates of 4 to 6 per cent for investments that aren’t regulated, aren’t part of the compensation scheme, can’t be placed in Isas and which you can’t sell or transfer to anyone else. If you’re looking for “the bond bubble”, I think I might have found it.