The Fool's Guide to Buying U.K. Retail Bonds

Do you want an income of 7.5% a year from your investments? There are retail bonds from FTSE 100 companies that are set to pay these kinds of whopping yields.

As you probably already know, there are some impressive dividend yields available on blue-chip shares right now. The problem is that dividends are never guaranteed, and a cut can crash a share price.

However, there is another way: company debt, or bonds. These are fixed-income investments, and the income stream is guaranteed until redemption -- provided the company stays in business! You see, bond interest has priority over dividend payments, making them appeal to conservative investors.

Unlike shares, bonds usually have a maturity -- i.e., a limit on how long they can be owned. When a bond matures, investors are paid back the principal amount (or par value) of the bond -- typically 100 pence. Investors then have to find another home for their cash.

In 2010, the London Stock Exchange revolutionized the way private investors could invest in company debt. The Order Book for Retail Bonds, or ORB, is an LSE trading service for corporate bonds, gilts, and supranational debt (such as the European Investment Bank). Most retail bonds can be bought for a minimum investment of just 1,000 pounds, and for many investors, the ORB will be the easiest way to build a diversified bond portfolio.

The tax treatment of retail bonds helps, too. They are exempt from stamp duty, for one thing. Provided the bonds mature more than five years from the day you invest, they can be held in a self-select ISA.

Two years ago, there were 49 gilts and 10 corporate bonds available on the ORB. Today, there are 53 gilts and 100 corporate bonds. There is a broad range of corporate bonds listed on the ORB. This means an investor can easily build a diversified fixed-income portfolio.

Below I've listed a selection of corporate bonds that are available today on the ORB. Remember that on maturity, interest payments end, and every bondholder is paid 100 pence per bond.

*Flat yield on bonds is the annual interest payment divided by the price to buy the bond.

I've picked out three that are of particular interest and demonstrate the role bonds can play in an investment portfolio.

Tesco
On the ORB today you can buy debt in Tesco at 118.5 pence. The Tesco 6% 2029 bond (LSE: 40OS) will return 100 pence to investors in 2029. Until then, bondholders receive the 6 pence interest payment once a year. At today's bond price, the 6 pence-per-annum interest payment on Tesco bonds equates to a yield of 5.06%.

When considering a bond investment, it helps to see what is on offer from the same company's shares. This year, Tesco is expected to pay shareholders a dividend of 15.1 pence per share -- a yield of 4.9% against a 308 pence share price. While the bonds give a guaranteed payment, the shares present the possibility of divided cuts or increases. I wrote recently how Tesco had increased its shareholder dividend every year for 28 years. Given that record, it looks as though Tesco's shares may be a better bet than the bonds.

Barclays
Barclays has disappointed shareholders in recent years. During the financial crisis, its dividend was scrapped as the company faced a battle for survival. As the company slowly recovers, its dividend is gradually increasing. Even with the recent market panic depressing the company's share price, Barclays' bonds are paying far more than the shares. The bonds currently trade considerably well below their 100 pence redemption price. This suggests the market remains worried not only about Barclays' ability to make profits, but also about whether it will survive at all. Investors expecting a recovery might be well served buying both Barclays' bonds and shares.

Enterprise Inns
Enterprise Inns is a textbook example of fixed income versus equity investment. Weighed down by its debts (that includes the bonds!), Enterprise Inns cancelled its shareholder dividend in 2009. 

Since then, the company has been paying bondholders 6.5 pence in interest for every bond held, and general concerns over the company's future pushed down the price of both the bonds and the shares. Indeed, that 6.5 pence annual bond payment is equivalent to an 8.1% yield to anyone buying today. However, if the 8.1% per annum sounds like an appealing return, you need to see the company's recent share-price chart. Shares in Enterprise Inns have more than doubled in 2012.

Enterprise Inns demonstrates how bond and equity investments can be opposite sides of the same bank note. While bondholders receive better income protection should a business encounter difficulties, it is the shareholders getting in near the bottom who can enjoy big returns following a recovery.

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