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Richard Hunter

Generating income from corporate bonds

By | Thu 05 April 2012

It's of little surprise that we are often asked by clients for additional ideas on how to generate income. With UK interest rates likely to remain at 0.5% for some time and most savings accounts on the High Street returning nominal amounts of interest, holding cash is all very well, but investors run the risk of their capital being eroded by inflation.

We have previously discussed the merits of cash generative companies, indeed, FTSE 100 companies are on average currently yielding around 3.5%, but corporate bonds can offer investors even higher yields (all income yields are variable and not guaranteed).

For investors willing to take a higher risk attitude compared to holding cash, but not wanting to buy ordinary shares, corporate bonds continue to be an investment destination of choice.

Furthermore, corporate bonds with 5 years left until maturity can be held in an ISA or a SIPP (Self Invested Personal Pension) which, although subject to change, means they would be free of any income or capital gains tax.

The basics

Corporate bonds are priced in £1 nominal units and are often subject to a minimum investment of £1,000 nominal.

Corporate bonds usually pay a fixed rate of interest and have a set redemption date when the investor should receive the return of their capital. As a general rule of thumb, corporate bonds are categorised as having 'investment grade' status (a high rating awarded by commercial credit rating agencies) or high yield (popularly known as 'junk bond') status.

The reason corporate bonds carry a varying level of risk is that they are, by definition, allied to the company which issued them. In the event of a company being wound up, they rank ahead of ordinary shares in terms of repayment and are in this way lower risk than ordinary shares. It is this possibility of default which accounts for the higher risk of certain corporate bonds, and is also usually accompanied by a higher return to compensate for this.

Nonetheless, investors should look at all available clues as to the creditworthiness and history of paying debts of the company in question. They may also take some comfort in a higher rating from the likes of Standard & Poor's or Moody's.

Potential investors should be aware that away from the blue chip bonds, liquidity can be a slight issue (the number of buyers and sellers may be limited and the spread between a bonds buy and sell price can be slightly wider).

Which bonds are available?

In terms of our clients, we have seen a great deal of interest generated by the current low-income environment. There is a wide range of corporate bonds available on our Vantage platform, for further details, including indicative closing prices, visit the corporate bond and gilt section of our website.

Another access point, which investors might like to consider, are corporate bond funds, which invest in a range of bonds in order to spread the risk.

The Royal London Corporate Bond fund is currently in our Wealth 150 (our list of favourite funds across all the major sectors) and the managers have recently increased the fund's exposure to bonds issued by companies, which are less economically sensitive. This includes utilities companies, whose services remain in demand regardless of economic conditions. The fund currently holds bonds issued by French electricity provider EDF and Stirling Water as well as other more 'defensive' bonds including those of Imperial Tobacco. As with all investments this fund can fall as well as rise in value and so should be held for the long term.

Find out more about the Royal London Corporate Bond fund

Corporate bonds are not without risk and in general, a higher yield reflects greater default risk. The performance of the bond will remain closely linked to the fortunes of the underlying company - and indeed inversely with interest rates - but at least they provide an income opportunity, which is increasingly difficult to find in times such as these.

How to buy Bonds?

Once you are familiar with corporate bonds and gilts, including how they work, you can place a deal in an existing Vantage account by calling our dealers on 0117 980 9800 during market hours (Mon-Fri, 8:00am-4.30pm), it is not possible to buy or sell corporate bonds via our online service. Bonds may not be suitable for all investors and neither income nor capital is guaranteed. If you are unsure of their suitability please seek advice.

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