High-street names go for corporate bonds

What used to be an expensive market is coming within reach of investors with shallow pockets. Chiara Cavaglieri and Julian Knight report

Staff at John Lewis and Waitrose were today braced for their first bonus cut in three years (PETER MACDIARMID / GETTY IMAGES)

Warren Buffett, the world's most successful private investor, once said that a rule for private investors was to "invest in companies you really like".

For most Britons, the names they see on the high street every day are those which inspire confidence and loyalty – from big-name retailers to, yes, even banks. Familiarity breeds not contempt but investor interest.

The most obvious way to invest in a company is by buying shares, but as any investor in BP over the past few years will tell you, even blue-chip stocks can underperform. So a potentially less dangerous way is through corporate bonds, in effect buying the loans of big companies.

The corporate bond exchange has yet to spark much enthusiasm from everyday private investors, but with Lloyds, John Lewis and Tesco dipping more than a toe in this market, it could be in for a makeover.

Investors looking for big-name appeal can now access individual corporate bonds directly from the retail bond market, which was launched by the London stock exchange (LSE) back in February 2010. Previously, corporate bonds, (which are essentially IOUs from companies looking to raise money) were typically issued at a minimum of £50,000, which meant that the market was beyond most investors.

"The retail bond market offers welcome relief to investors and savers struggling to find similar returns elsewhere," says Paul Killik, senior partner of Killik & Co. "We applaud companies like Lloyds that are helping to re-create an active bond market for private investors to put them on a par with institutional investors."

Lloyds is the latest company to take advantage of this new platform, unveiling a five-and-a-half year bond paying 5.5 per cent last week. John Lewis shoppers and employees can also invest between £1,000 and £10,000 in a new five-year Partnership bond which provides a healthy return of 6.5 per cent, made up of 4.5 per cent interest plus 2 per cent in John Lewis gift vouchers. Both moves follow Tesco Bank's seven-year corporate bond paying 5.2 per cent launched in February which raised a colossal £125m for the supermarket giant, hinting at more Tesco bonds on the way.

The Lloyds bond is available until 22 March with a minimum investment of £1,000, then blocks of £100 thereafter. It will be traded on the exchange and can be sheltered in an individual savings account (ISA) or Sipp providing it has a maturity of more than five years at the time of purchase.

"There are some key differences between this and the John Lewis bond. The Partnership bond won't be traded on the LSE. Because the Lloyds bond is traded investors can sell at any time, but the price might be less than they paid for it, so they could lose some of their capital," says Adrian Lowcock of independent financial adviser (IFA) Bestinvest.

The John Lewis bond is available to staff members and customers holding a John Lewis Partnership or Account card who apply for investment by 11 April, with the bonds sold on a first-come, first-served basis. The appeal for regular John Lewis and Waitrose shoppers may be clear, but there are two significant drawbacks.

First of all, unlike many corporate bonds, the John Lewis bond cannot be held in an equity ISA. Secondly, although one benefit of company bonds over savings bonds is that the money can be moved without penalty, investors must keep their money tied in for the whole five-year term. So, investors have no flexibility to sell the bond before the end of the term if they need the money and could even miss out on the opportunity to cash in on any increased value (although there is always a capital loss risk as well).

With any corporate bond, there are many other pitfalls to be aware of and, in particular, investors must remember that any fixed income is vulnerable to inflation. With interest rates set to rise, a return of 6.5 per cent may not seem as impressive in two or three years' time.

"It could look less attractive at some point in the five-year term of the product, if the bank rate starts to increase and other providers increase their savings rates accordingly. We are advising our clients not to fix their savings for any longer than a one-year term at the moment, due to the prospect for higher interest rates during this time," says Martin Bamford of IFA Informed Choice.

The returns from a corporate bond are also liable for tax, so basic rate taxpayers tempted by the John Lewis bond will actually earn just 5.2 per cent after tax, and higher-rate taxpayers only 3.9 per cent. Crucially, unlike savings accounts, corporate bonds are not covered by the Financial Services Compensation Scheme (FSCS). In the unlikely event that John Lewis goes under, investors will see their money go down with it.

With this additional risk, investors should quite rightly expect considerable reward, but for savers who have yet to max out their tax-free ISA allowance, there are cash accounts that rival the rates offered by Lloyds and John Lewis. Skipton Building Society, for example, has a five-year fix paying a tax-free return of 5 per cent and benefits from FSCS protection.

To get some diversification, a corporate bond fund may a better alternative as they use a basket of individual corporate bonds to spread risk.

"Corporate bond funds are a bit more expensive, but you've got a professional fund manager looking after it and something like 50 to 100 holdings, if not more, rather than just one for your money," says Mark Dampier from IFA Hargreaves Lansdown.

At the other end of the scale, investors looking to make smaller companies part of their investment plan instead can access impressive returns through a venture capital trust (VCT).

Investors buy shares in the VCTs and then rely on the managers to pick fledgling companies with the potential for growth, aiming to sell that stake down the line. These are very much high-risk investments, but the big pull here is the generous tax breaks; investors receive tax-free dividends and tax relief at 30 per cent, so for every £100 invested, the taxman effectively gives back £30. There are strict rules about the size of the companies held; for example, they must have fewer than 50 staff, and the investment must be held for at least five years.

"The range of possible investment is very broad; from lower risk VCTs which tend to be designed to produce a low but predictable return, to companies which are more traditional fast-growing companies," says Guy Myles, managing director of Octopus Investments.

For brave investors, Enterprise Investment Schemes (EISs) work in a similar way to VCTs. However, these concentrate on a single company, making them more of a risk than VCTs. Even worse, the tax benefits could be under scrutiny at the Treasury after Chancellor George Osborne questioned the merits of VCTs.

"The big things to consider are: can you commit your money for a minimum holding period; are you eligible for the tax breaks; and do you fully understand and are you comfortable with the investment risk?" says Mr Myles.

Expert View

Martin Bamford, Informed Choice

"The John Lewis Partnership bond is an interesting product, although any use of a word 'bond' to describe a financial product can cause confusion. Investors in this particular offering will not get any protection from the Financial Services Compensation Scheme (FSCS)."