My Portfolio: Hard work, but worth it

Opportunism is the active investor’s middle name. So, although I had not previously invested in corporate bonds, I took a closer look as once-in-a-lifetime bargains began to emerge.

Driven by the twin effects of the paralysis of the banking system and the deep recession, corporate bond prices have fallen so far that, by March, they were effectively pricing in levels of default of 30-40 per cent – double the peak rate during the Great Depression. The flip side has been a surge in yields, which has put the returns from bonds – issued by troubled firms such as Enterprise Inns, as well as safer companies such as Standard Chartered – into double digits.

How justified is this fear? Moody’s reported that the default rate in the 12 months to March was seven per cent, but this was expected to reach 15 per cent worldwide in 2009 as a whole, and as high as 19 per cent in Europe. That may be high, but it isn’t as high as prices suggest.

This was intriguing and, at first, I thought that I would buy into a corporate bond fund or an exchange traded fund (ETF). However, some of the managed funds had hefty fees, and many did not seem to offer the kind of yields I had hoped for. One alternative – the iShares Sterling Corporate Bond ETF – seemed to be three quarters based on bonds from banks and financials, which would seem to warrant a higher yield than the 8 per cent this ETF offered. So, I took a look at individual bonds.

Once you start to shop for corporate bonds, you realise what a wilderness it is for the private investor. First, you discover that the minimum investment in most bonds is £10,000. Then, you find that little research is available on individual bonds, the market is opaque and the bid-offer spread is anything up to 15 per cent.

None of the three brokers I use was able to provide online dealing facilities or online prices. I had to deal by phone. Considering the publicity given to corporate bonds, I was surprised to find dealers so unprepared. Most I spoke to had little knowledge of the market, had no lists of bonds they could deal in, nor an easy way to relay prices.

Given that most corporate bonds are eligible for self-invested personal pensions (Sipps) and those with five years or more to run are eligible for individual savings accounts (Isas), that was surprising. But one pleasant surprise was that dealers even at low-cost execution-only brokerages (I must commend iDealing here) were willing to spend time going to and fro to marketmakers, in order to get up-to-date prices and relay my questions to these specialist jobbers.

In the end, I bought two bonds. Both are just about investment grade, rated at BBB+ by S&P, but both fairly obscure:
● Standard Chartered’s 8.103 per cent perpetual preferred, with a floating rate coupon and callable from 2016, by which time I hope it will be back to par. Even accounting for a giant spread of 51.5 to 67 per £100, the ask price gave a running yield of 12 per cent. ● Aviva 5.9021 per cent 2020 direct capital instrument, which I managed to get for just 38 per cent of face value, giving a running yield of 16.8 per cent. High risk, perhaps, for a bond. But it makes a safer and higher income investment than ordinary shares in Aviva, especially as it is classified as core structural debt. No payment can be missed without Aviva first suspending all dividends. As Aviva held its ordinary share dividend, that gives a hefty capital buffer.

Nick Louth is an active private investor, writing about his own investments. He may have a financial interest in any of companies, securities and trading strategies mentioned.