20 June 2018

More excitement than you bargained for

Bonds are often described as safe investments. “Safe” here relates to the probability of you getting your money back. Government bonds, or Gilts, are seen as being very safe because the UK Government can always print money; so the risk of default is low.

by John Royden

Head of Research


But “safe” should not be taken out of context. In mid-2013 the 3.5% of 2068 were trading at close to £100. As interest rates fell, the gilt rallied to a peak of just under £200 by August 2016; within six months the gilt was down at £164. So here is an example of a “safe” investment which doubled in price in three years and then fell 15% in quick succession. “Safe” does not mean “lacking in volatility” due to interest rate risk.

More recently we have seen other risks in the retail bond market and by “retail” we mean bonds with small minimum denomination sizes. The minimum deal size in many so called “institutional” bonds is £100,000 nominal which takes the market out of the reach of many private clients. Retail bonds have a minimum trade size of c£1,000 but with many having minimums of £100. Many of these bonds are traded on the ORB, a market run by the London Stock Exchange.

Most recently we have seen the family of four Provident Financial bonds see-saw in value. A year ago, the Provident Financial PLC 5.125% 09-OCT-2023 was trading at £110. After the firm’s profit warning in September 2017 the bonds collapsed to £86 as investors fretted over default risk. Following a low of £65 the bonds then bounced back to trade at £97 after the announcement of the March rights issue.

Other examples of volatile bond behaviour of late include the Premier Oil plc 6.5% 31-MAY-2021 and the EnQuest PLC 7.0% 15-FEB-2022. The Premiers fell from £97 in May 2015 down to £38 by February 2016, whilst the EnQuests fell from £87 down to £31. But the good news is that they have both since recovered on the back of stronger oil prices and, in the case of Premier Oil, a renegotiation of the covenant and an extra year to maturity, enticed with a higher coupon. EnQuest had to reset its notes to PIK (Payment In Kind). The Wasps Finance Plc 6.5% 13-MAY-2022 also breached their covenant which had to be reset, however, the Wasp bonds are under pressure again from interest cover worries and a late filing of their accounts.

Other kinds of risks that have driven volatility have included rating risk, which is the fall or rise in value when a credit rating agency down- or up-grades a bond’s credit rating. We have seen this with the Paragon Group of Companies PLC 6.0% 28-AUG-2024 PAG3 which rose into a new Fitch BBB rating.

Prospectus risk has recently manifested itself in the Aviva PLC 8 3/4% Cumulative Irredeemable Pref Shares (Aviva As). Back in March, Aviva offered the opinion that they were legally entitled to cancel these “irredeemable” shares. The Aviva A prefs collapsed in price from £175 down to £103 in short order and took much of the irredeemable preference share universe with them. Luckily some political pressure on morality as well as the dubious legal standing of the proposal has driven Aviva to retract their stated intention and the Aviva As are back at £158, with the company offering compensation to those who sold into the false market.

So recent volatility is a reminder that bonds are not always as “safe” as you might imagine and of course, it is important to remember that past performance is not a guide to future performance. But given that the ORB has been running for eight years without any interest or capital default, I don’t think that is too bad a record. The vast majority of retail bonds have generally behaved in line with “what it says on the tin”. And the moral of the story ... run a diversified portfolio or look for bond funds.


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