T2W Trading Community

Access for the private investor

So, I hear you say, how can I get involved? Surely the word of Gilts, Bunds, Treasuries and Eurobonds is only for the banks and other professional players.
To a degree, this is true, and although the US and Europe have a thriving market in fixed income securities, the UK has, as yet, not made much progress in this direction. Certainly, private investors wishing to buy £10,000 worth of bonds will receive short-shrift from the major investment banks, who generally deal in clips of $10 million and above.

However, the last few years have seen this situation improve. Bondscape is a consortium backed by fixed-income market-makers Barclays, Winterflood and HSBC. This consortium set out to provide liquidity and transparency for the private investor by creating an online platform which allows retail brokers to see (and deal on) prices for small lots across a range of Sterling and Euro denominated bonds. This platform also provides valuable information such as credit ratings, yields to maturity and other analysis. The most useful feature for private investors (who are not allowed to deal directly on the platform) is the closing price data, which provides vital transparency in this historically opaque market (see sample webpage, below). To view the full set of these these closing prices, see www.bondscape.net.

Finding a broker who will deal in bonds can present more of a problem. The average broker will have little knowledge of this area, and even less interest. Most full-service and advisory brokers will be, at a pinch, able to deal in non-Gilt bonds but the problem here lies with the charges……. Let’s face it, there is not much point of acquiring an asset with a 50bp margin over cash if you have to pay 150bp in commission. This, of course, is particularly true if one is buying short-term bonds, which may have five years or less to run to maturity.

Thus, as with all business transactions, it pays to keep your costs low. Some of the online discount brokers are now offering the ability to buy corporate bonds. This year I have been using Squaregain (www.squaregain.com), who will deal for fixed cost of £12.50 to buy a bond. This works out at around 50bp (half a percent) on a £2,500 holding, which is quite acceptable providing the bond has more than a couple of years to run.  

And how about timing?

One advantage of a bond, as opposed to a share, is that eventually you get your money back! This means that a portfolio of fixed income securities with different maturity dates will provide a steady flow of cash through coupons and redemptions. Given that these cash flows will be re-invested into new bonds, over a period of time market price movements are to a large extent rounded out of the portfolios performance.

This technique, known as a “laddered” portfolio softens the effect of entering the market at too high a level, but nevertheless, it is always nice to buy at the lower end of the range, rather than the higher end!

Takeovers are one area where the active trader can pick up cheap assets. If a company is the subject of a leveraged bid, bond holders will be wary of being swamped in new debt. Thus, credit ratings for the company are downgraded (or put on review) and risk-averse institutional holders will head for the exit.

A good example of this is the GBP denominated Marks & Spencer 5.625% March 2014, a ten year bond issued in March 2004, just before Phillip Green’s attempted takeover of the retailer.

The chart shows the bond plunging in price to a low around 82% as the takeover came into play. At this level the bond had a yield to maturity of around 8.4%, good value by any standard.

Price chart from Bloomberg terminal

Subsequent price action has seen the price make a full recovery, leaving holders fortunate enough to buy the dip with both a high-yielding asset and a decent capital gain.

So, in a nutshell, remember that equities are not the only gain in town and that owning long-term yield may well serve you better than trading short-term volatility. When reviewing your ISA and SIP choices for 2006, don’t forget to add a few bonds!