It is cheaper for the company to go direct to Joe Public, on top of which they save any fee paid to the fund manager. This trend should also keep the corporate bond fund manager honest and will hopefully stop – or at least slow down – those fund managers who charge an AMC for simply holding a basket of bonds from the bigger multinationals, adding little value to the end investor.
Coupon saving…for who?
Another cost saving for the issuers is that the coupon paid to the retail client is often lower than for the institutional investor and this – on top of other inherent risks involved with any direct promotion – has all the hallmarks of another mis-selling scandal in the making.
Steve Snowden, co-manager of the Kames Investment Grade and Absolute Return Bond funds, is not quite as gung-ho about the mis-selling angle, but he is able to illustrate the retail/institutional discrepancy.
He gives the example of Provident Financial that, in March issued a 7% 2017 retail targeted corporate bond. Typically, an intermediary will also get a 0.5% commission hthough some do rebate this back to the retail customer.
Institutional buyers like Snowden, however, can get a better yield from the company’s other bonds, such as an 8% 2019 bond that currently yields close to 8%.
“While some of that extra yield is compensating institutional investors for lending money for an additional two years, this is still a much bigger differential than is normally observed in the corporate bond market,” he argues.
The credit risk is the same as both are issued by the same regulated entity but the yield for the retail investor is considerably lower. Does the investor’s saving of the AMC he would pay to Snowden to own the institutional bond cover the difference in yield? No.
There are plenty of other reasons Snowden is able to give to argue the case for owning a corporate bond through him rather than buying direct – you’d be surprised and disappointed if he said anything else.
Institutional corporate bonds are priced more keenly than their retail equivalents; institutional bond issuance is normally bought up within hours keeping retail investors out; institutional bonds have large minimum investment amounts making diversification virtually impossible for retail investors to achieve.
Corporate bonds and corporate bond funds
However these arguments come from Chris Kitchenham, a director at Walker Crips Stockbrokers, someone who manages private client portfolios, including bonds, and the firm’s corporate bond fund.
On the plus side for retail investors, he says: “They are usually priced in a ‘private client unfriendly manner’ by reference to yield, with no set initial price. This compares to retail corporate bonds which are priced at par with a fixed coupon rate, a maturity date and an issue price of £1, making them far easier to understand for the general public.
“Furthermore, institutional corporate bonds require large scale purchases for access, with typical minimums set at £50,000. Retail corporate bonds can generally be purchased in denominations as small as £100, making them more accessible. This accessibility is the key for [private] clients.”
His conclusion is that both have a place in the market for those looking to raise capital.
“Corporate bond funds with institutional corporate bond holdings will always find a place in well managed investor portfolios with their professional management, diversification and access to more keenly prices bonds. Now there is a viable alternative for the private investor, i.e. accessing the company debt directly via retail corporate bonds. The less keen prices are balanced in part by the lack of fund management fees,” he argues.
The answer is that both have a place and as long as individual investors fully understand the risks then retail corporate bonds will continue to be made available.
But what adds fuel to Snowden’s fire is the Financial Service Authority’s view of what a retail client can be advised on by an ‘independent’ adviser.
The FSA’s finalised guidance says: “Independent advice is defined as a personal recommendation to a retail client in relation to a retail investment product where the personal recommendation provided meets the requirements of the rule on independent advice.”
It goes on to say: “Examples of financial instruments that are not retail investment products would include…an individual fixed interest security…”
So from 1 January, 2013, an independent adviser cannot recommend a bond to a retail client, but a ‘restricted’ adviser can.