Looking at the world of bonds is a good thing. Even though stocks get all of the attention, bonds are definitely worth looking into. A UK investor trying to get into the game will find that bonds just make sense. In short, bonds are really money that you give to a company. The company in turn pays you interest for using your money for their own gains. If you buy a bond for 100 pounds with an interest rate of 5% over the next 10 years, the company owes you the interest along with the 100 pounds. They have to pay back the funds that accrue to a bondholder.
Bond returns are pretty fixed. In the event that a company has to be shut down, a bondholder will be paid before the stockholder. Now that doesn’t mean that stocks are bad and bonds are always good. You have a chance to see stocks fly sky high, whereas bonds don’t fluctuate like that.
There are a lot of different bonds on the market place right now. You have UK government bonds, referred to as “gilts”. These are bonds that are directly issued by the government to finance public spending. UK gilts will be rated AAA by major credit rating agencies, and are viewed as risk free from default. The price fluctuates from day to day in the market, and investors will pay at or below par for them. They will hold the bonds to maturity.
There are conventional gilts, that pay a fixed coupon and mature at a set date. The life of the bonds vary from a few months all the way out to 50 years. The most popular gilts have a maturity of two to ten years. Some gilts are complicated because they have calls, which enables the government to retire the debt ahead of time.
There’s also index-linked gilts. These are instruments that do not pay a fixed coupon or amount on redemption. They are linked to the UK retail prices index (RPI). It’s also important to realize that there’s a time lag on the RPI used to calculate the coupon and redemption period, and this is designed to offer a hedge against inflation.
There’s perpetual gilts as well — no set maturity date. They may or may not be paid back at a time of the government’s choosing. If you didn’t catch that, it means that this is pretty risky!
Corporate bonds are known as sterling dominated non-Gilts. They’re issued by companies but can also be issued by foreign governments and other organizations. The prices of these bonds will move alongside the market’s expectations for interest rates. Yet the price will also be affected by the credit quality of the issuer. You will need to compare the “spread” (incremental yield) offered over a Gilt of the same maturity.
There are also convertible bonds, where the holder can convert their redemption proceeds into the equity of the issuing company. This can offer a combination of yield and growth for investors.
The market is always changing, which means that you definitely need to read up on just about everything that you can when it comes to bonds. Reading the financial news is a good way to keep track of the market. A well informed investor makes better decisions!