James Bond or Corporate Bond?

When it comes to corporate bonds, American political consultant James Carville said it best: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

Bonds are different

It’s easy to assume the UK stock market is huge. At around some £2.42 trillion it’s even larger than the £2.27 trillion-sized UK economy.

But it has a big sibling … and its name is bond.

The UK bond market is some $4.3 trillion in scale. That’s about £3.6 trillion. This, in turn, is dwarfed by the whopping $133 trillion global bond market. These data come from the excellent Visual Capitalist website, below.

Bonds are attractive

Why the shock and awe numbers?

Because, from an investor’s perspective, corporate bonds are starting to look attractive once more. Let me explain.

Bonds like low inflation and reasonable interest rates. And we now have both.

Between late 2001 and early 2024, UK inflation was above 4%. Then, the yield on the 10 year gilt – where you lend to the British government for 10 years – was mostly well under 4%. Add the two together and you’ve a recipe for wealth depletion.

But now inflation is around 3% and this 10-year bond is paying around 4.26%. Much more appetising.

The relationship between bonds and rates is a little more complex. Say you’re that CEO or FD. You agree the interest rate with the bank, issue the bond to a willing market, and then … WHAM … interest rates go up, other companies issue bonds with higher rates, and no one wants your bond anymore.

Today’s interest rates are 5.25%, which is an attractive level for bonds. For example, the energy company Centrica issued a 30-year corporate bond on 14 May 2024, paying a yield of 6.48%.

Provided they don’t get into difficulty and struggle to pay out, Centrica is contracted to pay you an arithmetically competitive rate – for 30 years.

Counterintuitive?

One of the reasons bonds can be a bit of a mystery is that seesaw effect of interest rates going up and bond prices going down. It can seem counterintuitive. The American government has a good way of expressing it:

The other confusing thing is that, when you buy a UK corporate bond or government bond your interest is paid in pounds, not as a percentage. So, a 4.2% government bond, priced on issue at 100p, pays you 4.2p a year. If markets subsequently price the bond at, say, 90p, you still get your 4.2p … but as a percentage yield this is now 4.66%. A price drop to 80p pushes the yield up to 5.25%.

Overall, a higher yield indicates a higher risk. So, the sober suits at the European Investment Bank will pay you 4.06% over five years, while a bond from German property investors Aroundtown Finance Sarl yields 11.53% on a perpetual basis.

How to buy

If you fancy lending to the UK government, you can do it through the Government itself or with an intermediary. You’ll definitely need the latter if a corporate bond catches your eye. You can’t buy a new bond, only one that’s been issued and is available for trading.

Single securities are a risky thing of course, even with government bonds. Remember the Truss-Kwarteng budget that almost crashed Britain’s bond market?

Which leads us to funds. This is where an investment professional, with or without a powerful computer, creates a portfolio of debt securities to spread risk and (ideally) boost overall returns.

The giant and respected American firm Dimensional Fund Advisors is a case in point. They balance their portfolios with calls on inflation, interest rates, currency risk, new bond issuance, credit quality (i.e. whether a borrower is worth lending to) and myriad other factors that make bond markets so weird and wonderful.

When we work with firms like Dimensional, we use bonds to help balance out the risks in an equity-heavy portfolio. That’s because when shares go down, bonds often go up, and vice versa … but perhaps that’s another article altogether.

If this article has piqued your interest, we’d be very happy to talk bonds or anything other aspect of your investments. Please get in touch on hello@firstwealth.co.uk or call 020 7467 2700.

If you’d like to know more, please get in touch on hello@firstwealth.co.uk or call 020 7467 2700.

[1] https://www.ons.gov.uk/economy/investmentspensionsandtrusts/bulletins/ownershipofukquotedshares/2022

[2] https://www.statista.com/topics/3795/gdp-of-the-uk/#:~:text=In%202023%2C%20the%20gross%20domestic,and%202.176%20trillion%20in%202021.

[3] https://www.visualcapitalist.com/ranked-the-largest-bond-markets-in-the-world/

[4] https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/l55o/mm23

[5] https://markets.ft.com/data/bonds/tearsheet/charts?s=UK10YG

[6] https://www.ramseycrookall.com/latest-bond-issues/

[7] https://www.sec.gov/files/ib_interestraterisk.pdf

[8] https://www.ramseycrookall.com/latest-bond-issues/

[9] https://www.ramseycrookall.com/latest-bond-issues/

[10] https://www.dmo.gov.uk/responsibilities/gilt-market/buying-selling/purchase-sale-service/

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.