Corporate bonds represent one of the largest financial markets in the world, offering investors regular income in exchange for financing companies.
This guide explores how corporate bonds work, their benefits and risks, and how to invest in them from the UK.
But, for those short of time, what are corporate bonds? Corporate bonds are debt securities issued by companies to raise capital, typically with a fixed interest rate and maturity date. Investors who purchase these bonds are essentially lending money to the issuing company in exchange for periodic interest payments and the return of the bond’s face value at maturity. They are considered a relatively low-risk investment compared to stocks but generally offer higher yields than government bonds.
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What Are Corporate Bonds & How Do They Work?
A corporate bond is essentially a loan made by an investor to a company. The investor provides capital to the company, and in return receives regular interest payments plus repayment of the original loan amount on a set maturity date.
The annual interest payment is called the coupon and is usually fixed for the bond’s lifespan. The end repayment amount is known as the principal, face value, or par value.
For example, a £1,000 bond with a 5% coupon would pay £50 interest every year, then repay the £1,000 principal at maturity.
Bonds can be bought and sold on secondary markets before maturity. Most corporate bonds trade over the counter through broker-dealers, with some listed on exchanges like the London Stock Exchange.
Why Do Companies Issue Bonds?
Companies sell bonds to raise capital for business purposes like:
- Funding research and development projects
- Expanding operations
- Refinancing existing debt
- Financing mergers and acquisitions
Bonds may offer cheaper financing than bank lending. Companies can tailor bond offers to investor risk appetites by adjusting factors like coupon rates, maturities, and collateral.
Assessing Credit Risk
Before buying a corporate bond, investors must assess the credit risk – the chance the issuer may default. Rating agencies like S&P and Moody’s assign credit ratings to indicate risk levels.
Higher-rated bonds have lower coupons as they are safer. More speculative “junk” bonds must offer higher yields to attract investment.
Key Differences From Stocks
While both tradeable securities, bonds and stocks have key differences:
- Stocks make you a part-owner with voting rights. You receive dividend profits if the company does well but may lose money if shares fall.
- Bonds make you a creditor entitled to fixed interest and principal repayment. Your returns are limited but risks are reduced.
So stocks offer higher but variable returns, while bonds provide lower but more predictable income. Bondholders also get priority over shareholders if a company fails.
Investing in Corporate Bonds in the UK
There are several ways to buy corporate bonds in the UK:
- Through a broker – they can access both exchange-listed and OTC bonds on your behalf
- On trading platforms – some provide retail access to bond dealing alongside stocks
- Via bond funds – pooled investments that hold a basket of bonds to diversify risk
Consider factors like risk appetite, investment size, and holdings timeframe when choosing bonds. Seek professional advice if unsure.
Corporate bonds offer regular income streams in return for financing businesses. By understanding how they work and evaluating risks, UK investors can potentially benefit from exposure to this vast market.
Buying Corporate Bonds Directly
When a company issues bonds, it usually hires an investment bank to underwrite the offering. The bank buys the bonds first then sells them on to big institutional buyers.
The high minimum investment size often puts direct purchases out of reach for retail investors. However, some brokers facilitate smaller purchases, providing the chance to own actual corporate bonds.
Be aware that direct bond ownership brings risks like default. Study issuers’ credit ratings and financials carefully before investing.
Investing in Corporate Bond ETFs
Exchange-traded funds (ETFs) offer a more accessible way to invest in corporate bonds. ETFs buy baskets of bonds, allowing you to gain exposure through purchasing shares in the fund.
Key benefits of corporate bond ETFs:
- Diversification across many bonds
- Potential for regular dividend income
- Low management fees
- Can be traded easily like stocks
However, ETF shares don’t mature like bonds. And the fund’s composition can change, affecting risks and returns.
Learn about an ETF’s holdings and strategy before investing. Work with a registered advisor if unsure.
Read my guide on how to invest in ETFs UK.
Which Investment Method is Right for You?
Consider your investment goals, time horizon, and risk tolerance when deciding how to invest in corporate bonds.
- Direct bonds offer fixed returns but require large investments. Better for buy-and-hold.
- ETFs provide diversified access in small amounts but add intermediary risks. May suit traders.
ETFs can provide exposure to bonds in retirement accounts like ISAs. Weigh up all factors before choosing your strategy.
Keep Watch on Your Investments
Once invested, monitor your bonds or ETFs closely. Check issuers’ ratings frequently. With ETFs, watch the fund’s composition and performance.
Use stop-losses if investing directly. Set price alerts on ETFs. Be ready to adjust your portfolio as economic conditions evolve.
Corporate bonds offer attractive income potential but require research and monitoring. With the right strategy, they can play a valuable role in portfolios.
Are Corporate Bonds a Good Investment UK?
The suitability of corporate bonds as an investment in the UK—or any other jurisdiction—largely depends on your individual investment goals, risk tolerance, and overall financial situation.
It’s essential to consult with a financial advisor to determine whether corporate bonds fit well within your investment portfolio.
Here are some points to consider:
- Predictable Income Stream: Corporate bonds typically offer a fixed interest rate, providing a predictable income stream.
- Lower Risk than Stocks: While not risk-free, corporate bonds are generally considered to be less risky than equities. Companies are legally obligated to make interest payments to bondholders before distributing dividends to shareholders.
- Diversification: Corporate bonds can offer diversification benefits when added to an investment portfolio primarily composed of equities.
- Variety of Options: There are numerous corporate bonds available in the UK market, ranging from those issued by well-established companies to newer or smaller firms, and from high-yield, higher-risk bonds to investment-grade bonds.
- Liquidity: Corporate bonds often offer better liquidity than other fixed-income securities like municipal bonds or CDs.
- Interest Rate Risk: Bonds lose value as interest rates rise. Long-term bonds are particularly sensitive to rate changes.
- Credit Risk: There’s always the risk that the company issuing the bond could default on either the interest payments or the return of principal.
- Limited Upside: Unlike equities, bonds offer limited upside potential. You won’t benefit much from the issuing company’s growth except through the fixed interest payments.
- Inflation Risk: The fixed interest payments might not keep up with inflation, particularly for long-term bonds.
- Liquidity Constraints: While generally more liquid than other fixed-income securities, corporate bonds can still be less liquid than equities, particularly those from smaller issuers or those with lower credit ratings.
Other Factors to Consider:
- Taxation: Interest earned from corporate bonds is subject to tax, unlike the income from certain government bonds.
- Regulatory Environment: Be aware of any regulatory changes in the UK financial market that might impact corporate bonds.
- Economic Indicators: Things like inflation rates, interest rates, and economic growth can influence corporate bond prices.
- Market Conditions: Sometimes external events can lead to decreased liquidity or increased volatility in the bond market.
Investing in corporate bonds via a fund can help mitigate some of these risks through diversification, but it’s essential to understand the associated fees and the competency of the fund managers.
Given these factors, corporate bonds could be a suitable investment for those looking for a relatively stable and predictable income stream but are not ideal for those unwilling to take on interest rate, credit, and liquidity risks.
Always consult a financial advisor to assess how corporate bonds fit into your overall investment strategy.
Key Questions on Buying Corporate Bonds
How do I buy corporate bonds in the UK?
To buy corporate bonds in the UK, you can use a brokerage account from platforms that offer bond trading or through a financial advisor. Once your account is set up and funded, you can browse available bonds, evaluate their ratings and yields, and make a purchase based on your investment strategy and risk tolerance. Some online platforms also allow you to buy corporate bonds directly from the issuer during the initial offering.
Are corporate bonds worth investing in?
Corporate bonds can be a worthwhile investment for those looking to diversify their portfolio and generate a steady income stream. They generally offer higher yields than government bonds, but come with varying degrees of risk depending on the issuer’s creditworthiness. As with any investment, it’s important to assess your own risk tolerance, financial goals, and conduct thorough research before investing in corporate bonds.
Are corporate bonds tax free UK?
In the UK, corporate bonds are not generally tax-free. Interest received from corporate bonds is subject to income tax, and any capital gains realised upon selling the bond may also be liable for capital gains tax. However, if the bonds are held in a tax-advantaged account like an Individual Savings Account (ISA) or a pension, the interest and capital gains could be tax-free.