Don’t Invest in a Fixed Income Bond Until You’ve Read This
Have you been thinking of investing in a fixed income bond? Fixed income bonds are a worthwhile addition to any investors portfolio as they offer alternative advantages and disadvantages to traditional stocks and shares. With continued uncertainty across the financial markets paired with consistently low-interest rates, there is an emerging trend towards investing in bonds as they can provide a higher return on investment capital. The Investors Chronical recently reported that:
“UK investors withdrew more than £2bn from equity funds on a net basis in the first half of 2019 and, by contrast, put nearly £6bn into bond funds.”
Bonds are desirable because they are a good diversifier in an investment portfolio and often less volatile than other equities like stocks and shares. Sophisticated investors understand the need for a diverse portfolio and make sure they invest in a unique blend of different asset classes. Investors do this to spread the risk and ensure better stability if one investment drops.
The popularity of fixed income bonds is on the rise in 2019. We here at Meredith Charles have created a checklist to help anyone considering purchasing a bond. We will be using the Pardus Fixed-Income alternative investment bond (as featured on our website) as an example throughout this article. Bear in mind that this checklist is useful for any investor considering any other bond available in the market.
Make sure you understand the fixed income bond coupon rate
A significant advantage of bonds is that they offer a fixed coupon rate, guaranteeing an investor a pre-agreed interest rate per annum. Whereas, the value of stocks and shares can go down as well as up depending on market fluctuations, so they do not offer the same assurance as bonds. Knowing the exact return on investment is very appealing for investors as they can forecast their revenue in advance rather than trying to speculate their return.
Understanding the actual value of the coupon rate is vital to forecast the return on investment. For example, PARDUS Fixed-Term bond offers a coupon rate of 24% per annum. Investors purchasing PARDUS can predict their return over the lifetime of a bond, which is impossible to do with traditional stocks and shares.
Investors must understand all the terms and conditions of a fixed income bond to realise their return fully. Once the coupon rate is fully understood, investors know the exact return on their investment, which investors cannot predict with traditional stocks and shares.
Know the Redemption Date and Minimum Subscription
Fixed income bonds will often have a minimum subscription. You can buy shares for as little as a £1, but bonds require a minimum level of purchase. The minimum investment in a fixed income bond could be as low as £2,000 or higher, like £100,000 in PARDUS Fixed-Income Bond.
An investors capital is committed to a bond and may not be withdrawn until the redemption date when the bond reaches maturity and expires. An investor buying a bond will need to be comfortable with not accessing their capital for the term of the bond. In contrast, stocks and shares can be bought and sold at the investor’s discretion.
Once a bond matures, the issuer will repurchase the bonds at the price pre-agreed price. For example, Pardus Fixed-Term bond will pay 98% of the initial investment back after the two-year term. So, if your initial investment is £100,000 then at the end of the term you will receive back £98,000 in addition to the interest earned over the two years.
Redemption dates on bonds can vary in length. Shorter-term bonds are often regarded as more desirable to investors, as they are less susceptible to interest rate fluctuations compared to intermediate, or longer length bonds. If interest rates skyrocket over the term of the bond, the fixed interest is devalued in comparison and this situation is less likely to happen over a short period.
Some short-term bonds will offer an early exit strategy, like PARDUS, which has an early exit strategy after 12 months which uncommon but available on some bonds.
Recognise the risks
All investments have risks. Every financial website has a caveat by law clearly stating the element of risk involved. Any uncertain investor should seek professional advice from a regulated financial advisor.
There are two main risks when you buy a bond. One is that the issuer goes bust and the other one is interest rate inflation, although, with stocks and shares, you are susceptible to these risks too.
One of the most prominent risks to bonds is rising interest rates – as touched on earlier. Stocks and shares can also be vulnerable to interest rate fluctuations with many investors wanting to dispose of any stocks and shares in industries that may be negatively affected by rising rates. The other risk is that the company issuing the investment opportunity goes belly-up. There is not much anyone can do when this occurs.
To fully understand the risks, you need to understand fully what you are investing in and how that will generate revenue, whether it be stocks and shares or bonds. For example, PARDUS operates on a pre-sold policy. This method of trading takes advantage of the price difference between two or more markets, generating profit by matching deals that capitalise on this price imbalance. The transactions must occur simultaneously to avoid exposure to market risk.
Know your compensation rights
The FSCS stands for Financial Services Compensation Scheme and offers protection to investors when financial firms fail. The FSCS covers savings accounts if a bank or building society goes bust, and investments sold by regulated firms in certain limited circumstances, but it will not include retail or unregulated bonds. Subsequently, if the issuer goes belly-up and defaults, the investor will not be eligible for financial compensation under the FSCS.
Similarly, the FSCS will not compensate stock and shareholders if the company they have invested in goes into administration. Still, investors may get compensation if a regulated investment product provider goes bust, or for a loss arising from bad advice.
As a result of this, some bonds may offer a form of capital protection to put investors minds at ease. PARDUS fixed-term bond has taken out capital protection insurance from the ‘Top 5’ A+ rated insurance provider, Willis Tower Watson – who services some of the world’s most-recognised multinational companies. The Bond Fidelity Insurance Policy provides an indemnity in the event of any actual or alleged act, error, misstatement, misleading statement, omission, neglect or breach of duty or loss of capital. This insurance provides a parallel level of capital protection to that of the FSCS.
Understand the tax implications of fixed income bonds
With stocks and shares, the investor is subject to stamp duty to be paid upfront. The investor will also have to pay income tax on dividends, and capital gains tax on any profit accumulated between the cost of the initial buying price of the investment to the selling price.
The good news is that bonds are not eligible for stamp duty. However, you will be taxed in any monies you earn from the fixed coupon rate. The tax is charged at the highest marginal income tax rate, so the rate of tax will be dependant on your annual income and current tax bracket. All earnings from the bond will be added to your income. Consequently, your tax bracket will be calculated on the total sum of your earnings that year. If the investor is a higher rate taxpayer, they will also be subject to paying a higher rate tax on monies earned from their fixed coupon rate.
Getting access to fixed income bonds
Bonds are often hard to come by as not all brokers as a matter of course offer access to Bonds. If you are you would like to know more about investing in bonds, ask your financial advisor to advise you on bonds suited to your individual circumstances.
If you would like to know more about PARDUS fixed-income bond, please feel free contact us.
Are you ready to invest in a fixed income bond?
Ensuring that you know all the answers to the above points will help you when deciding to invest in a bond. If you have any questions don’t hesitate to contact us.
The views expressed in this article are those of Meredith Charles. They should not be considered as advice or recommendation to buy, sell or hold a particular investment. They reflect our personal opinion and should not be solely relied upon when making investment decisions.