Corporate bonds and gilts
What are corporate bonds?
After government bonds, the corporate bond market is the largest section of the global bond universe. With a vast array of maturities, yields and credit quality available, investing in corporate bonds has the potential to provide higher yields than government bonds and diversification benefits for investors.
When companies want to expand operations or fund new business ventures, they often turn to the corporate bond market to borrow money. A company determines how much it would like to borrow and then issues a bond offering in that amount; investors that buy a bond are effectively lending money to the company according to the terms established in the bond offering or prospectus.
Unlike equities, ownership of corporate bonds does not signify an ownership interest in the company that has issued the bond. Instead, the company pays the investor a rate of interest over a period of time and repays the principal at the maturity date established at the time of the bond’s issue.
While some corporate bonds have redemption or call features that can affect the maturity date, most are loosely categorized into the following maturity ranges:
- Short-term notes (with maturities of up to five years)
- Medium-term notes (with maturities ranging between five and 12 years)
- Long-term bonds (with maturities greater than 12 years)
Why invest in corporate bonds?
Corporate bonds can offer a range of potential benefits including:
- Diversification: Corporate bonds offer the opportunity to invest in a variety of economic sectors. Within the broad spectrum of corporates there is a wide divergence of risk and yield. Corporate bonds can add diversification to an equity portfolio as well as diversify a fixed income portfolio of government bonds or other fixed income securities.
- Income: Corporates have the potential to provide attractive income. Most corporate bonds pay on a fixed semiannual schedule. One exception is zero-coupon bonds, which do not pay interest but are sold at a deep discount and then redeemed for full face value at maturity. Another exception is floating-rate bonds that have fluctuating interest rates tied to a money market reference rate such as the London Interbank Offered Rate (LIBOR) or federal funds rate. These tend to have lower yields than fixed-rate securities of comparable maturities but also less fluctuation in principal value.
- Higher yields: Corporates tend to provide higher yields than comparable maturity government bonds.
- Liquidity: Corporate bonds can be sold at any time prior to maturity in a large and active secondary trading market.
What are gilts?
Gilts are bonds issued specifically by the British Government. A conventional gilt will pay you a fixed cash payment every 6 months until maturity, at which point you will receive your final payment and the return of the initial investment.
You can sell corporate/government bonds at any time, and because prices go up when interest rates fall, modest capital gains are possible. These gains are tax-free on Government bonds and some corporate bonds. Interest earned is usually taxed, unless bonds are held in an Investment ISA.
The potential return from corporate bonds is generally higher than from government bonds, to compensate for their extra risk, volatility and liquidity – they are only as safe as the financial standing of the company that issues them. If the bond issuer collapses, you will be paid before shareholders, but it may turn out that there is nothing for anyone. Therefore, you should ensure that you select an issuer which meets your risk profile.
The difference between bonds and stocks & shares
The major difference between bonds and stocks & shares is that shareholders have a stake in the company, whereas bond holders are lenders to the issuer. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely.
Bond prices go up and down like share prices but not as much. The issue price is linked to long-term interest rates, but once issued, their value will go down when rates are rising, and up when interest rates are falling.
How do gilts & bonds work?
Bonds are usually issued at £100 each and pay back £100 when they mature, plus interest at a fixed rate each year until then. If you buy in the market for more than £100 after they are issued and hold the bond until maturity, you will get back less than you invested, However, you may be prepared to do this because the interest that the bond offers is higher than what’s available in the market at the time and overall you make a profit. If you pay less than the issue price you will make a gain on the repayment of your capital, but it is likely the interest rate will be lower than what’s available in the market. So when buying a bond or gilt you should consider the overall return that it offers you.
How to apply
You can call Molton Wealth Financial Services directly on +44 (0)20 3874 4495 or email and request a call back.