Throw your caps in the air! The LSE brings bonds to the masses

The London Stock Exchange is offering retail investors the chance to trade corporate bonds. James Moore says many believe it is long overdue

Which would you rather lend to: Tesco or your bank? After the events of the past three years it would surprise no one if the majority were to say Tesco.

But until now, lending to companies by investing directly in their corporate bonds has been all but impossible for all but the wealthiest individuals – that rarefied subsection of society catered for by private banks for whom £50,000 is but a drop in a very large ocean.

That is because to invest directly in a bond issued by even a blue-chip company has typically required a minimum investment of £50,000 or more. So the "retail" investor has effectively been treated in a similar way to members of the hoi polloi attempting to get through the door of Bouji's nightclub when Prince William and his pals are in town.

Not any more, however. The London Stock Exchange (LSE) yesterday launched its attempt to bring corporate bonds to the masses. Marking the occasion, LSE chief executive Xavier Rolet dispensed with the City's traditional topper and instead threw a cloth cap into the air.

No snazzy names either – the LSE's new venture will be known by the utilitarian title of the"Retail Bond Platform". That platform has been set up to target retail investors, and will allow them to buy and sell bonds in a similar manner to shares. Investors do need a broker but there should be execution-only operations, which will offer the services for a small fee for those people who don't require advice.

At least at first, there are only a limited number of companies available to trade in – just 10 corporate bonds are on the platform at launch, although they do include securities issued by blue-chip or bluish-chip companies such as BT, National Grid, GlaxoSmithKline, Morgan Stanley, GE Capital, Enterprise Inns and, of course, Tesco. And the minimum trading size will be in the region of £1,000.

That may get smaller with time, however. Royal Bank of Scotland yesterday blazed a trail by issuing a 10-year bond paying 5.1 per cent that can be bought for as little as £100. Given its current reputation and genius for generating bad publicity, the RBS name attached to a bond (which doesn't carry the sort of implicit government guarantee that the bank's deposits enjoy) might cause some retail investors to think twice.

On the other hand, it would be difficult to find the sort of yield the bond offers in more conventional savings products, with interest rates as low as they are at present. Ben Board, director, RBS listed products, says: "RBS is one of the leading issuers of bonds for private investors in Europe. The LSE's development of a similar market in the UK is a great advance, and now RBS can provide British investors with opportunities like its 5.1 per cent bond, which can offer a reliable, dependable income stream but doesn't require investors to lock away their capital."

Investment banks that advise on bond issuance are certainly looking closely at the new service – which will work to their advantage by widening the pool of investors available for new issues. Said one of the leading advisers: "We're very interested in taking part, and we will likely make an announcement within the next few weeks. Retail investment in bonds is quite common [elsewhere] in Europe." That is certainly true. The LSE's inspiration for the "Retail Bond Platform" comes from the success of the hugely successful operation run by its Italian subsidiary.

Borsa Italiana's highly successful MOT market (there's that problem with the name again) recorded €230bn (£201bn) worth of trading in 2009, which made it Europe's largest retail fixed- income market.

But it's not just Italy. Investing in bonds is relatively common on the Continent, particularly when compared to equities – by contrast to the situation in Britain.

Gillian Walmsley, product manager at the LSE, says: "There is a far more established culture of equity trading in Britain. In Europe they have more experience and knowledge of how fixed-income works. But in the current conditions, with interest rates very low and equity markets volatile, we think there is a real appetite in this country to look at fixed-income trading.

"It is always difficult to say how quickly it will develop, but if we look at the established market run by Borsa Italiana, last year there were 3.5m transactions."

Private-client brokers, who are likely, at least initially, to provide much of the trading volume for the new market, are also keen, although they do want to see at least some guidance from the Financial Services Authority before jumping in head first.

Magnus Wheatley, director of communications at broker Charles Stanley, said : "In general it looks like a fantastic idea for our clients, particularly given that you can trade for less than £50,000. So we are very much in favour."

However, as Mr Wheatley says, at least in the early days there are potential drawbacks, particularly when dealing with small-size bonds like the £100 RBS offering. "If you get down to that sort of size you can find that spreads (the difference between the buying and the selling price) can be really quite wide. They tend to decrease only as you move up to larger bonds."

Bonds or bond funds: The adviser's view

So are bonds a suitable investment for the small investor? The independent financial adviser Amanda Davidson, a director at Baigre Davies, says they could fulfil a useful purpose to a number of groups who have previously been shut out of the market due to the huge size of the minimum investment.

Of the London Stock Exchange's new market, she says: "Really, it's something of a surprise that no one has done this before, particularly if you consider the fact that people have been trading individual equities for years and they are both more volatile and more risky than corporate bonds."

However, Ms Davidson says that they should not be seen as risk-free. "First of all you do have to take a view on whether the company you are buying into is good for the money." Ms Davidson points out that there have been plenty of incidents where companies that were seen as "safe as houses" have subsequently proved to have been built of straw. Even when they have boasted the bluest of blue-chip names. Just look at the banks.

An individual corporate bond pays a fixed coupon every year and returns the initial investment back at the end of its term (five years or more) in full. At any time during that period, the bond can be sold on, although you could lose money by doing this, depending on market conditions at the time.

Bond funds work differently. They usually aim to pay a set sum of income each year, but to get that, you are basically relying on the skill of a fund manager, who will trade in and out of a portfolio of different bonds based on the markets and how he or she thinks they will perform. There is less risk in one way – because the risk is spread across a number of bonds. But the income yield can change to your disadvantage if the fund manager gets it wrong.

Says Ms Davidson of individual bonds: "They are the sort of product that could be of interest to people who have a need for a fixed sum of money every year. For example, people who might be putting away money for school fees. This initiative also allows people to put their own portfolio of bonds together.

"But they might not be suitable for everyone. For many investors, a fund may prove to be the better option, but I am in favour of the London Stock Exchange's idea."