Key Takeaways
- The UK stock exchange has widened retail investor access to corporate bonds, by allowing issuers to lower the minimum investment requirement.
- Alphabet recently issued £5.5 billion as part of a growing trend of US tech giants tapping global debt markets to fund the buildout of AI infrastructure.
- However, yields aren’t as compelling as in the past, says Morningstar senior portfolio manager Mark Preskett.
Retail investors now have greater access to direct corporate bonds, as part of efforts by the London Stock Exchange and the UK government to reinvigorate the country’s capital markets.
This widening of the investor base was helped by the entrance in the UK corporate bond market of Google owner Alphabet GOOGL, which issued £5.5 billion of debt in February, including a “century” bond maturing in 2126, which was almost 10 times oversubscribed.
Is Widening Retail Access to Corporate Bonds a Good Idea?
In January, the London Stock Exchange announced rules aimed at opening up the UK’s corporate bonds market to retail investors. A new framework for issuing retail-friendly “Plain Listed Vanilla Bonds” lowers the minimum investment required from £100,000 to as low as £1.
LSEG LSEG, the company that owns the exchange, became the first mover in using the new structure by converting three bonds worth a total £1.4 billion to the new structure at the end of April, which are now eligible to be held directly by retail investors.
John Dobson, head of investment solutions at Interactive Investor, called the move a “great first step” toward democratizing fixed income.
“This is hopefully the first of many more to come, as the market continues to remove structural barriers that have historically limited access to institutions.”
While the move to widen retail access is seen as positive, fund managers have reservations on the suitability of certain direct corporate bonds for retail investors.
“Investors need to be aware of the risks they’re taking,” says Aegon Asset Management’s head of UK fixed income Iain Buckle.
“If it’s a well‑known household name and the credit risk is easy to understand, that’s one thing. If it’s more complex, with less transparent information, that makes me nervous," he says. “A vibrant retail bond market could be positive, but investors need to understand the credit risk, the liquidity, the trading costs, and what happens if they need to sell,” adds Buckle, who co-manages the Silver-rated Aegon Global Short Dated Climate Transition Fund.
According to Buckle, the strong saving culture in the UK may be an obstacle to a wider takeup of corporate bonds. “I have no issue with a retail bond market, but I don’t think it will ever be huge. UK retail investors tend to prefer fixed‑rate savings products with banks over lending directly to corporates through bonds.”
Are Corporate Bonds Suitable for Investors?
Morningstar Wealth senior portfolio manager Mark Preskett also highlights the complexities of assessing bond issuances.
“Corporate bonds absolutely have a role in a diversified portfolio, particularly for lower‑risk investors, those with shorter time horizons, or those wanting a more balanced portfolio,” he says. “Most multi‑asset funds hold corporate bonds, and they typically trade at a spread over government bonds. That higher yield reflects credit risk.”
However, Preskett warns due diligence is crucial. “Bond issues often come with hundreds of pages of legal documentation, including covenants and embedded call options that can disadvantage investors if rates change,” he says.
“You don’t want to lend to a company with excessive debt, as higher leverage increases the probability of default. Most retail investors won’t do that level of analysis, so this is very much a buyer‑beware market," he adds.
Which Companies Issue Bonds in Sterling?
The corporate bond market has been in recovery mode since fixed-income markets globally took a hammering in 2022.
The sector, similar to global fixed income markets, sold off following the Russian invasion of Ukraine as energy prices and inflation surged, prompting the Bank of England to rapidly raise interest rates.
Over three years, however, the Morningstar UK Corporate Bond Index is up 13.2%, ahead of the Morningstar Global Corporate Bond Index when converted into sterling.
The UK corporate bond market has also shifted in recent years from a hub for international companies seeking to issue longer-dated bonds to a more domestic-focused market, though foreign issuers still play a sizable role. London remains a key hub for issuing eurobonds, which are corporate debt instruments issued in many currencies.
“Sterling has struggled on a relative basis compared with Europe,” says Aegon’s Buckle.
“As the European investment-grade market has grown, many companies have decided they no longer need to borrow in sterling. It’s often more efficient, cheaper and quicker to raise funding in euros.”
Foreign companies often list in sterling to diversify currency risk across larger issuances. Alphabet’s move into the sterling corporate bond market in February established it as one of the largest issuers in the asset class. Continental European and US issuers represent the largest holdings in the Morningstar UK Corporate Bond Index.
What’s the Outlook for UK Corporate Bonds?
Despite the entry of US tech giants into the sterling bond market, Damien Hill, a manager on the Gold-rated BNY Mellon Strategic Bond and BNY Mellon Responsible Horizons UK Corporate Bond funds, says the sector can act as a shelter from AI disruption.
The sector has significant exposure to physical assets, particularly utilities and housing associations, and less exposure to trade war risk, AI disruption or cyclical industrials than other markets, Hill says. “If a software company is disrupted by AI, recovery values can be negligible,” he says. “In regulated utilities with hard assets, recoveries are generally much better.”
Recovery value is what investors or creditors get back on their original investment if a company goes under. Bond investors usually rank higher than equity investors in the event of a liquidation, according to Hill.
“There is also very little autos exposure, limited commodities and fewer cyclicals. That makes the market more robust against current global market pressures.”
Corporate bonds are often used as a diversifier to stocks in traditional portfolios. Morningstar’s Preskett says credit spreads—the extra amount of yield earned over safe government bonds to compensate investors for the extra risk taken in lending to companies—are currently tight, meaning investors aren’t particularly rewarded for holding corporate bonds at the moment.
“This is a good time for companies to issue debt, but the yield advantage for investors is smaller than it was five years ago,” he says. “Even recent volatility driven by the Iran conflict hasn’t led to meaningful widening in credit spreads. Investors aren’t pricing in higher default risk yet, so returns aren’t especially compelling.”
