Can Blue Chip bonds pay you an income?
AS THE Bank of England cut interest rates to a record low of 0.25pc and yields on the continent fall into negative territory, finding a decent return on fixed income investments is becoming increasingly difficult.
So intense is demand that this week a site launched offering individual savers access to big corporate bonds for as little as £100. Traditionally these have been a good way to get an income from an investment.
But there are fears that savers are taking on ever-more risk for ever- dwindling rewards, and if interest rates rise again they could get locked into investments. Earning a decent yield on investments is vitally important for many savers, especially those in retirement who take their interest payments as an income while keeping their money invested.
But surging demand for a reliable income stream in recent years has forced yields down.
It’s a simple case of supply and demand. Ten years ago a tenyear Government gilt paid interest of 4.6pc, today it pays just 0.65pc. To make anywhere near the same amount in interest as they used to, savers have had to look at increasingly risky options. Savers who would usually have stuck to a savings account have turned to investments. Investors who would never have invested in company debt have been forced to do so.
UK investment grade corporate bond yields – those typically issued by big blue chip firms – have fallen from 5.5pc to 2.25pc over the past decade. And those who invested in investment grade company debt, have moved up the risk curve to high-yield or so-called junk bonds.
It’s great news for companies, of course, because they can borrow from investors at incredibly low rates to fund expansions or acquisitions, or to pay down existing, more expensive debt.
ON Monday Microsoft issued debt to the tune of £15bn to help fund its acquisition of social network firm LinkedIn.
It is the fifth largest corporate bond on record and one of just two which have been given an AAA credit rating by Standard & Poor’s – a better rating than Apple or even the UK has.
The ten-year bond pays interest of 2.4pc – just 0.9pc more than US Treasury bonds pay. A 30-year option from Microsoft offers a yield of 3.73pc. It’s estimated that demand for the bond was so strong it was oversubscribed – £37bn of orders for just £15bn of bonds.
Lloyd Harris, manager of the Old Mutual Corporate Bond fund, is one of those who have invested in the bond. He says: ‘Microsoft’s last few products have been well received and this acquisition allows the firm to integrate more products.’
The risks to these bonds come if things change. When interest rates do go up, the interest paid starts to look a lot less attractive, and that can also make them harder to sell.
The same is true if inflation rises which, with a weaker pound, recovering oil price and glut of money from QE, is possible. Interest rate rises also increase the chances of companies defaulting on their debt.
If investors were to get spooked there is also the possibility that bond funds could bolt their doors just as property funds did after the EU referendum.
If too many savers tried to get their money back and funds couldn’t sell their bonds quickly enough to meet these redemptions they could suspend trading. But with interest rates having just been cut, there seems little likelihood of this for the time being.
For now, the biggest concern is that yields may fall further if demand continues to soar. Simon Evan-Cook, head of multi-asset at Premier Asset Management, says savers should defer to an expert fund manager to sort the good from the bad.
He likes the Baillie Gifford Corporate Bond and Royal London Corporate Bond funds, which both yield 3.8pc.
He says investors hunting for income shouldn’t be tempted to go for super high-risk funds which are entirely in junk bonds or emerging market debt. The rewards may be greater, but the risks are too.