Inflation busting: Tesco Bank launches RPI-linked bond

What about deposit protection? Although this bond is issued by a UK bank, I don't believe investors will enjoy deposit protection.

Are you saying that the capital value will go down if RPI drops below 5.4% ? Or if the RPI has risen and then fallen back to 5.4 the capital will go back to £2000?

If so this is a most unattractive issue. As I read it your statement "if the RPI rises by say 30% ----- your £2000 investment would be paid out at £2600 means an RPI of 35.4%, or is it 1.30 x 5.4 =7.2 %. It is confusing, yet you suggest that the capital value would go down except for the guaranteed refund.

Lorna

Spot on

As I understand it - you get RPI plus 1% as a coupon paid every six months. At maturity you get your capital back plus any interest unpaid (i.e. from last coupon date to maturity payment date).

This is not a bank deposit and there is no protection - if Tesco Bank (a separate (subsidiary) company to Tesco plc goes bust, you could lose all of your capital.

Coupon is 1% so 1% return which increases by 5.4% if inflation remains as is (unlikely) = 1% x 1.054 etc

Capital returned in 8 years uprated by RPI. Min £2,000 returned.

If you sell in market you could lose cash due to fickle markets, inflation expectations, etc.

8 years is far too long to tie up capital for such a poor return.

How does

Tesco is undoubtably a good company with a Baa1/BBB+ rating re. Tesco bank.

As an investor I need to beat inflation and yesterday added to a holding of a BBB- rated bond paying a coupon of 9.25%. I paid 64.75 which means I get interest of 9.25 divided by 0.6475 = 14.2857142857% which is slightly over current official inflation rates.

The bond is a 'perpetual' (with a pretend maturity date of 2049 but with an option for the company to buy back at 100 in 2015) so carries a slightly lower rating than if the maturity date was fixed. Perpetuals are considered more risky but with a 9.25% coupon I believe the price shall rise until inflation becomes greater than say 8% to 10% and then one might be able to get a better return elsewhere.

I realise that with a return of over 14.28% interest per annum that the risk is slightly more than Tesco bank but I cannot be content with a return that only keeps up with inflation; if and when the price recovers to nearer par (100) I can either keep the bond with a lower yield on its market value (back down to 9.25% if it is worth 100 to sell) or sell at a handsome profit.

Should the bond price continue to drop I can either panic or buy more at an even higher yield; it's all very, very good fun [if a little stressful].

In an article today Smart Investor says that when the herd are panicking you have the opportunity to make good returns out of companies you consider to be a good long-term risk. I believe he was talking about shares. The same thing applies in the corporate bond market.

Guys, be very careful with these products - I read the small print in the NG issue and basically this is not going to see RPI added on each year as an absolute - it is always relative to where it stood at the previous measurement point... so,

If it starts at 5.2% at the outset and the next year it is at say, 4.5%, then there is a relative decrease in the rate of inflation and your returns go down by a commensurate leval in that subsequent year.... so, even if we still have inflation in say 5 years time of 2%, but in each of the measured years it is decreasing annually, then I know that the NG issue, for example, will have seen you actually lose money.

With the Tesco issue, I believe it will be similar in construct, so, you could actually see yourself in 8 years time with your ( not inflation uplifted ) original investment and the rate of interest you may have received could actually start at the headline1% pa, but it could easily halve to say 0.5% over the full term, or even end up close to zero.

So, these are clever capital raising instruments to capture our fear factor as private savers and to get us into products that sound good - just do go and read the small print and talk these finer details through with your IFA's...

Hi Robert

you didnt mention the specific Bond - if you are prepared to share which one that would be most helpful, but if not, I understand....

bruce wedderburn

Sharing probably isn't particularly helpful as I live in the 'despicable' eurozone!

I have a small income in sterling but i mainly spend in euro and therfore like to avoid currency fluctuations by holding investments in the currency applicable - and in this case it's a bond denominated in euro.

The bond in question is the 9.25% BPCE 2015-49; a double risk whammy if you believe the euro is about to become as dead as the dodo plus that French banks are at huge risk due to their exposure to Italian and Greek debt; however, i take some comfort in the fact that BPCE paid back in April this year 100% of what they were bailed out by the French government; something that some of our banks in the UK have not been able to do.

There are, however, plenty of corporate bonds denominated in sterling that can give you a good return plus a HUGE market in USD bonds if you are inclined to take some risk with exchange rates.

As I originally said the bond I bought would certainly be perceived to be a greater risk than that offered by Tesco bank - I am prepared to take the risk as part of a diversified portfolio where I do not always expect to be a winner but expect to be a winner 80% of the time where the losses will be minimal compared with the considerable gains both in income and capital gains.

The reporting of RPI needs to be improved to help people to understand what is happening with their salaries and investments.

What is being used as the basis of discussions is the CHANGE in RPI, not the RPI itself. The current RPI is at a level of anout 238 ( http://www.ons.gov.uk/ons/datasets-and-tables/data-selector.html?cdid=CHAW&dataset=mm23&table-id=2.1), not the 5% previous year's increase in RPI.

Everyone is actually discussing how the RPI changes over time, not the RPI itself. Terminology has become confused and it leads to a misunderstanding of how a bond like this is set up.

I am interested but wonder if I would need a broker to buy it in the first place. At my age I might just get away with saving in this bond for eight years for a small sum of money - perhaps £3000. I couldn't do more I think.

This is the full low down.

The 8-year Tesco Bank bond will be linked to the Retail Prices Index (RPI), so if the cost of everyday goods, such as food and fuel, continues to rise, so too will the amount you receive in interest.

Investors will be paid twice a year with the interest rate, or coupon, based on an annual rate of 1% but adjusted according to fluctuations in the RPI. The bonds can be bought through stockbrokers and financial advisers until 9 December.

Interest rate can go up or down.

Each bond is worth £100 at face value and the minimum investment is £2,000, which would buy you 20 bonds. The amount of interest paid will be calculated based on the difference between the RPI at April 2011 (234.4), which was eight months before the issue and the RPI at eight months before each semi-annual payment, the first being on 16 June 2012.

So if you were to invest £2,000, and the RPI stayed the same, dropped or rose by no more than 1% during that 6 month period, the interest you would get would be £10, as your semi annual payment would be 0.5% (as the 1% is an annual rate).

If RPI rose by 3% over the six months then your coupon would be £10.20 but if the RPI fell by 3% then your coupon would be £9.80. During the six months from April to October 2011 the RPI rose by 1.53% to 238, which would have earned you £10.15 in interest on £2,000.

Capital can’t fall.

If you hold onto the bond until it matures in December 2019, you would get back your £2,000 plus an additional amount, assuming RPI is higher in April 2019 than it was eight years earlier.

For example, if the RPI rose by 1% per year for eight years, your capital return would be £2,165.60 and if it rose by 3% per year then the total would be £2,533.20. Even if RPI falls during the eight-year lifetime of the bond, Tesco Bank would still return the £2,000 in full, providing it is still in business.

Not FSCS protected.

The bonds can be held within a stocks and share ISA or a SIPP, so investors could get the tax benefits on any returns.

It is important to remember that this is a long-term investment and it’s about taking a bet on inflation rates over eight years and hedging against that. While your capital cannot go down, it could still not grow if RPI drops over that period and the interest on your investment could also be extremely low if that were the case.

Another note of caution is that the bonds are not protected by the Financial Services Compensation Scheme and although you could opt to sell them before the eight years is up, there is no guarantee that they would be worth as much as they are when you buy them.

Guys, this is TESCO, be afraid.