5% Yield Bonds

I am new to corporate bonds and have most of my investments in equities, mostly in what I hope are robust stocks paying circa 4%+ dividends. However I have recently diversified a bit into bonds and have bought the following:
HSBC 5.375% maturing in 2033
Tesco 5.5% maturing in 2033
Barclays 7.125%, no maturity date

These all seem sound companies to me and again pay over a 4% yield, in fact close to 5%. I know there are some less sound companies offering similar returns and I can understand why people would avoid them but what I do not understand is why people would buy bonds with a 2-3% return when these are available - what am I missing?

I appreciate that when interest rates go up bond prices are likely to go down but that is likely to be proportionate across the board and at that point equities might be taking a tumble and so bonds might still look good as a relatively safe haven. Any advice for a new bond investor appreciated.

Comments

  • The yields are good, but the maturities are very long. When the interest rates start going up, there will be better yields on offer.
    I'm still not too keen on banks. There's been one scandal after another and who knows what bad debts they still have on heir books?
  • You said that

    "I appreciate that when interest rates go up bond prices are likely to go down but that is likely to be proportionate across the board"

    What you have missed is that long dated bonds such as the ones you have bought will not react in the same way as short dated bonds if interest rates rise.

    Taking your HSBC bonds as an example, if you hold the 2033 to redemption the price will drop from the current 105 to 100 and each year you will get a coupon of 5.375 so your overall yield to redemption is around 5%. There is an HSBC 2.875 maturing in just over a year that has a yield to maturity of 2%.

    The reason you may pick the 2% bond is that you know you will get 100p in a years time and HSBC probably wont go bust. Interest rates probably also wont change much in that period and even if they do the price of the bond wont move far from 100p.

    However what if interest rates go up over the next 10 years to say 8% and stay there (maybe extreme, maybe not). I haven't done the complex maths but the price of your 2033 bond would fall significantly to say 75p as your 5.375 coupon is now looking unattractive with market yields of 8%. So you are facing a possible large loss of capital if you chose to sell (of course you don't have to sell you can wait until redemption). There may also be further banking crises, perhaps HSBC will get into trouble and not be able to pay coupons.

    So that is the gamble with long dated bonds and why they have higher interest rates. You are fixing your return at 5% for almost 20 years and over that period anything could happen.

    A mix of maturities, some short some long, some fixed, some linked to inflation would be a more conservative and diversified approach.

Sign In or Register to comment.