The Sterling Bonds and Fixed Income Handbook. Mark Glowrey
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Preface
Who this book is for
This book is intended to fill a gap in the plethora of investment guides available for self-directed investors in the UK. Any number of books covering equities, leveraged trading, funds, ETFs and even alternative investments such as collectables are available, but to date the coverage of the gilt and corporate bond market has been slim. Of course, there are numerous works intended for investment professionals in this field, but these are highly specialised publications which typically focus on one aspect of the fixed income market, for instance credit derivatives or portfolio immunization – subjects that are likely to be of little practical use to an investor who wishes to build a small to medium size portfolio in the gilt and fixed income markets.
The professional investor also typically has distinct mandates to follow. These will usually be to achieve superior performance to his peers or an index, or to match future liabilities. Such investors will manage their portfolios accordingly. The private investor will typically have more straightforward criteria; to get a good return on his capital whilst avoiding unacceptable levels of risk. expense or complexity. This absolute return approach will frequently mean that the private investor’s selection of individual bonds, and the resulting portfolio may look quite different from that of the private investor.
The book aims to be a practical guide for UK investors and their advisors, enabling those with perhaps £10,000 and up, or a few £100,000s to put their money profitably to work in this rewarding and often overlooked asset class. The book is intended to be first and foremost a practical guide and covers both bond theory and the more mundane but important subjects of dealing, settlement and day-to-day portfolio operation.
I hope that Sterling Bonds and Fixed Income for the Private Investor will find a ready home on the bookshelves of investors, private-client stockbrokers, wealth managers, trustees and even a few fund managers. Company treasurers and investment bankers, particularly those employed in origination and new issues, may also find it a useful read, if only to remind them that there is demand from the man on the street, and how best that demand might be met.
What this book covers
This book covers the theory and the practicalities of investing in the UK government bond (gilt) and sterling corporate bond markets.
Virtually all categories of debt within this subset are dealt with over the following chapters: straight or vanilla bonds (the most common type) through to convertible, floating rate notes and index-linked issues. Both domestic and Eurosterling corporate bonds are covered – investment-grade and sub-investment grade alike. There is also coverage of the subordinated sector including permanent interest bearing shares (PIBS) and enhanced capital notes (ECNs), an asset class that already has a strong following amongst the UK private investor community.
Whilst the book is primarily intended for those investors who wish to put their money directly to work in the bond market, chapter 14 also covers bond funds and ETFs (exchange traded funds), comparing these popular investment vehicles with the do-it-yourself approach.
It is also worth considering what this book does not cover. As the title suggests, the book is intended as guide for UK investors, who will typically have sterling savings to put to work. Whilst chapter 12 deals with overseas and foreign currency bonds, this section will serve primarily to contextualize the more in-depth study of sterling bonds. The subject of overseas bonds is too great to be fully covered in one handy-sized volume. In particular, it would not be possible to cover the huge US domestic market and its subsets of tax-deductible, municipal and mortgage-backed debt.
Note: the book is illustrated with numerous examples of bonds trading the markets over the 2010-2011 period. Prices and interest rates will reflect those in force at that time.
Introduction
My initiation into the bond market was in the mid 80s at a very junior level as a London Stock Exchange clerk. I stood by one of the gilt jobber’s pitches whilst a very serious man in a pin-striped suit fired off a rapid string of coupons, maturity dates and prices denominated in complex fractions. It was a process seemingly designed to exclude the ordinary investor. By the early 90s I found myself still dealing in bonds, this time on the Euromarkets and in a wider range of currencies. Again, the industry was an exclusive club, trading huge blocks between financial institutions.
It struck me as strange that whilst I, and indeed many of my colleagues, made their living by selling and buying these instruments, most of us had never personally owned a bond. This was in considerable contrast to the frantic personal account dealing seen in the equity departments of most banks and brokerages. So I decided to give it a go, and by the mid 90s I was dipping my toe into the world of bonds with my modest savings. I soon discovered that investing your own money was a very different game to advising treasurers or fund managers – but more of that later.
The turn of the millennium saw me move into the world of independent research. Here I was able to pick up on the subject of bonds and the private investor in more detail, launching the www.fixedincomeinvestor.co.uk website and advising directly on a range of bond portfolios. It was a good time to be in the bond markets, which continued to outperform the turbulent equity markets of that decade.
Timing, of course, is everything. When I was investing in bonds back in the late 1990s there was an underlying bull market in the asset class, combined with enough volatility to make investing interesting; at times very interesting! But a reader today may ask: is now the time to be involved in bonds? I would suggest that, yes, it is.
Indeed, any serious investor should always be involved in bonds to some degree if he or she is to maintain a balanced portfolio. There are other, more immediate reasons to be involved in investing in bonds. The ultra-low interest rates that central banks have put in place look set to hold force until the middle of this decade, and income seekers are hard pressed to find returns. Whilst yields may be low on gilts, corporate bonds provide more substantial coupons. Sensible returns are available from respectable issuers and risks for investors lower than the equity market.
There are other practical reasons to get involved in bonds. The rapid growth of low-cost ISA and SIPP accounts has meant that every person can have their own personal tax shelter. Investors can keep and, importantly, re-invest, the interest they receive from bonds. Finally, the growth of the LSE ORB market has meant greatly improved access for private investors in the bond markets, a move that has been strongly supported by the UK’s private client brokers and wealth managers.
This book aims to help the average investor find his way into the bond market. I sincerely hope that bonds will soon become a permanent feature in your portfolio.
Mark Glowrey
Chapter 1: What’s a bond? Some key concepts
Everybody knows what shares are – buy a share and you own a small stake in a company. If the company does well and makes a profit, this may be distributed to shareholders as dividends. If the company continues to do well, these dividends will rise. Meanwhile, the capital value of your share, driven by other investors in the market, will likely rise.
That’s the plan.
But as most investors will tell you, it doesn’t always work out like that. Dividends may be conspicuous by their absence. Even reliable blue chips such as BP (or indeed most of the world’s banks) can be knocked for six by disaster, and dividends withheld for many years.
Bonds are different. A bond holder does not own the company – he or she is lending it money, and that loan comes with the usual package of conditions: a fixed annual or semi-annual coupon and agreed date of repayment. In a nutshell, a bond is this; a tradable security with a fixed interest payment and (usually) a pre-determined repayment date. The key point is this: the forward cash flows of the investment are known.
What is more, in the majority of situations the company does