Corporate Bonds: a beginner's guide

Corporate bonds represent a substantial slice of the global bond market (a third of it, according to the International Capital Markets Association), but corporate bonds have mostly been the preserve of professional investors, including funds and pension funds.

However, times are changing and regulators are making it easier for smaller investors to access this opportunity.

Why smaller investors should pay attention to corporate bonds

Corporate bonds are debt securities issued by companies. Unlike Gilts or Treasuries (government bonds issued by the UK and US governments respectively), corporate bonds are backed by the balance sheet of a corporation.

We are living in an era where some companies are now regarded as a better lending risk than governments (e.g. Apple), so it comes as no surprise that this market is being revisited by investors now.

Yet despite the sheer size and variety of the corporate bonds market, it has remained harder to access. With more opportunities to buy corporate bonds alongside shares now appearing, investors can tap into the more predictable economics and cash flow offered by bonds, plus interest (coupon) rates that are frequently superior to both bank rates and equity dividend yields.

By working through this Corporate Bonds guide, you’ll understand the following:

Corporate bonds vs equities: what’s the difference?
How does corporate bond pricing work?
What are the risks of investing in corporate bonds?
What makes corporate bond prices move?
Podcast: An introduction to corporate bonds
How can you invest in corporate bonds?
Corporate Bond news, insight and analysis

Corporate bonds vs equities: what’s the difference?

Corporations finance themselves using both equities and bonds and for company treasurers the bond issue is just as important, even more so, than the outstanding equities. The corporate bond market remains huge, larger than the equity market ($133 trillion in 2022 vs $122 trillion in total equity market capitalisation).

Ultimately the names are the same and the financial risks are similar, but it is your relationship with the company as an investor that differs when you buys its bonds.

If you own shares in a company, you are a part-owner of the business. You may be paid dividends, you may not. As we saw during the pandemic in 2020, there is nothing stopping a company from cutting or indeed suspending its dividend payments.

As a bond holder, you are a lender to the company. Not only is the company obliged to pay you back when the bond matures, it must also pay you interest on the bond during its term. The interest rate is set when the company issues its bond.

How does corporate bond pricing work?

Bonds change in price just like shares do. This will in turn affect the yield. The yield is a measure of the proportion of the interest payment versus the price of the bond – the bigger the yield, the more interest you are being paid.

The yield of the bond is very important and should not be confused with the coupon. The yield is effectively the amount of the value of the bond you could currently expect to earn in the year after you buy it. The yield will change whereas the coupon stays the same.

Yields are inversely related to bond prices. If the price of the bond goes down, the yield will go up. Note however that higher yields in the corporate bond market reflect perceived risk for investors: very high yields can reflect negative sentiment on the company in the bond market, and falling prices in its issued debt.

What are the risks of investing in corporate bonds?

The risks of buying corporate bonds are considered higher than, say, government bonds, as generally governments will not default on their debt. Owners of corporate bonds do have an advantage when it comes to a failure on the part of the company, as they will be paid by the administrators before shareholders are.

Indeed, when we look at capital preservation, it is shareholders who are paid out LAST in the event of company failure. ALL the bond holders have to be paid out first.

There are some other risks with corporate bond investing that do not apply to equity investing. Duration risk is there for longer-dated bonds (where there is still a long time until the bond matures). These longer dated bonds can be affected by changes in central bank interest rates.
The credit quality of the company issuing the bond is also important: some companies will take on a lot of debt, maybe more than they should and this represents risks for both bondholders and shareholders.

There is also an element of liquidity risk here – it can be harder to exit a bond position, even for a retail investor, than for the equivalent company’s shares.

What makes corporate bond prices move?

Bonds are priced differently to shares. The two core elements new investors in the bond market need to be aware of are:

Coupon – This is the return on investing in the bond. It is the interest rate attached to the bond – the interest the company will pay you – the lender – every year until the bond matures. Note that the interest is attached to the bond issue, not to the company. So companies can issue multiple bonds with different coupons.

Maturity – The other important aspect is the maturity, the date at which the bond finishes its life and money is paid back to lenders. There is usually a final coupon payment when this happens.

Bonds will be issued with a face value – e.g. £1000 – also known as par. Bond prices are quoted as a percentage of par. Investors will see bonds quoted with two prices as with shares. The ask price is the price you can buy the bond at. The bid price is the price you can sell at.

Podcast: Are you investing in Corporate Bonds yet?

How can you invest in corporate bonds?

The bond market is more opaque than the equity market. This makes it harder for investors to see prices on a day to day basis. Trades in bonds are made over the counter (OTC): there is no central exchange for corporate bonds to be traded on.

Another major historical obstacle for retail investors has been the large minimum trade sizes in the corporate bond market, typically of £100,000 or more.

In the UK specialist brokers are now able to offer investors access to this market, including the latest corporate and government issues. Fractional trading allows investors to get access to the economics of corporate bonds without having to commit large amounts of capital.