Understanding new issues: retail bonds

What you’ll learn:

• What retail bonds are
• Why it’s important to understand the risks involved
• How the new issue process works.

As with all bonds, retail bonds are a type of loan or ’I owe you’ note. In exchange for lending a company your cash, it will pay you a fixed rate of interest for a set period of time, after which your capital should be repaid in full. The main attraction is that the interest rate offered is typically higher than what's available from savings accounts. But the risk being taken on is much greater and unlike deposit accounts, bonds aren’t covered by the Financial Services Compensation Scheme (FSCS). So you could lose money if the company doesn’t pay the interest, or worse still, goes bust.

The London Stock Exchange (LSE) established the Order Book for Retail Bonds (ORB) – to allow companies to raise money from a whole new audience. All the bonds on the ORB are available in small, manageable trading sizes for private investors. The LSE offers a guide to this market on its website.

Credit risk assessment

People wouldn't lend money if they didn’t think they were going to get it back. So, you need to find out what kind of a credit risk the company will be to you.

Among your research, you'll want to read company accounts, reports and results. The LSE's information boards cover all the companies listed on the market. Read business reports in the media. Listen to market commentary to gauge how the company measures up to competitors. Look at its history to find out its record for good management, performance and profitability.

Details of what assets the company has secured the bond debt against should be included in the prospectus. It'll also show where you (the bondholder) stand in the queue of creditors if the company goes under.

You can also get some idea of how safe or reliable a bond is seen to be by its credit rating. If you’re thinking of buying individual bonds, credit ratings are worth researching from the start, and monitoring over the duration of your investment.

Usually, the lower the credit rating, the higher the rate of interest offered. But, equally, with a lower credit rating, comes a higher level of risk.

Credit ratings are worked out by specialist credit rating agencies – such as Standard & Poor's (S&P) and Moody's. The ratings are an assessment of the risk of a company or government not paying back its debt. Investors must take on board that a credit rating (however high) isn’t guaranteeing the investment is safe. Some so-called ‘high-yield’ bonds, offer a higher rate of interest but they come with much more risk and are often referred to as junk bonds.

Find out more about bonds and credit ratings

The launch of a fixed-income retail bond new issue

A company starts the process of a retail bond new issue by meeting groups of investors to gauge interest. Once satisfied that this could be a viable way to raise money, the company will release further details, generally in the form of a prospectus explaining the terms of the bond and showing significant dates.

The offer period begins when the prospectus is published. As with IPOs, the offer period is can be closed early if investor demand from investors is more than expected. Usually, an offer period will be two weeks. When it closes, investors' applications are formally confirmed with the allocation of bonds.

An open market

After the initial release, retail bonds are traded on the market in the normal way. So, the bond price will move up and down according to market forces and investors could find the value of their bonds fall below the price they bought them for. Equally, a selling opportunity for the bonds you hold may present itself if the market value rises above the price you paid.