Best bonds to invest in 2018
When it comes to bond investments there’s lots to consider, especially as buying bonds with the highest yields can lead to investment disasters. But there are safer ways to earn income from this asset class. Find out how with our guide to the best bond investments for 2018.
Investment bonds explained
When measured against inflation, interest rates in the UK are still pitiful — the Bank of England’s (BoE’s) base rate is just 0.5% and the interest rates paid on the best current accounts hover around 1.25%.
As an asset class, bonds can offer a significant yield pickup over and above bank interest rates, with issuers ranging from very safe (government bonds) to highly speculative (junk—rated corporate debt).
What you need to know before investing in bonds
Investing in bonds has traditionally been quite difficult due to minimum lot sizes in most issuances of £100,000. Innovation has seen a number of online firms get around this problem by buying some bond inventory and then splitting it up into smaller sizes for their clients. For instance, one site offers the Tesco March 2042 bond with a 4.875% coupon.
Putting to one side the risk of buying such a bond on one of those smaller platforms, this is not without considerable investment risk.
Investors need to remember the following:
- When buying an individual bond, such as Tesco, you take on the credit risk of that one company. If it goes bankrupt, you could lose all your investment.
- The longer the maturity of the bond, the greater the sensitivity to interest rates. If the Tesco bond’s yield rose from its current 4.2% to 5.2%, the price would fall by minus 12%. Effectively three years of income gone.
- Rating agency downgrades or economic instability could cause credit spreads to widen. Currently, bondholders receive 2.1% annual compensation for taking on Tesco credit risk, over and above government bonds. If the spread widened, in a similar manner to duration risk, this would see the price fall.
- The fact that you can hold a bond to maturity and get your money back (assuming no default) is not a reason for buying one. Inflation will erode your principal; in the case of the Tesco March 2042 issuance, 3% annual inflation between now and then would see a £100 investment worth just £48 in 24 years’ time.
Unless you are an experienced investor and comfortable in analysing company balance sheets, buying a bond fund, exchange traded fund (ETF) or Investment Trust is likely to be the best approach. While you will have some underlying management fees to pay, you will be much better protected by spreading your risk across potentially hundreds of different issuers. Therefore, if a few underlying bonds do default it should have a fairly modest impact on your total return.
Our roundup of the best investment bonds for 2018
IG recently produced a Top 50 ETFs 2018, which took a birds—eye view of the investment universe, including investment bonds, to come up with a number of fixed income asset classes that investors may want to consider owning. For the purposes of this article, we have taken those asset classes and included the yield to maturity, rather than the historic distribution yield of the ETF.
Available ETF asset classes for bonds
1. UK Government bonds offer very modest yields. The longer—dated bonds will be susceptible to short—term losses if interest rates rise. Inflation—linked bonds actually offer a negative yield to maturity — to make returns, investors will need inflation to rise over and above what the market expects.
2. Corporate bonds offer a slightly higher return than government bonds, about a 1% yield pickup. Short—dated bonds have a lower yield, but are less sensitive to interest rates.
3. High—yield bonds offer larger returns than corporate bonds, but have higher credit risk. Owning an ETF is much safer than holding the individual bonds. If you don’t want exposure to the US dollar, GBP— hedged ETFs are a better bet.
4. Emerging market bonds are a blend of local currency (e.g. Russian rubles and Brazilian real) and US dollar debt, which can be hedged into GBP. While you don’t have individual company risk, you do have some sovereign risk. For example, if Argentina was to default, this would have a negative impact on your return.