Owner or lender?

The forthcoming issue of a Tesco Personal Finance inflation-linked bond is creating a stir in the financial press.  This follows a similar offering from National Grid. 

For the record, the new Tesco bond will pay a coupon of 1% per annum, increasing in line with RPI (so if RPI increases by 5%, the coupon will increase to 1.05% p.a.).  The redemption price will also be increased in line with RPI.  The bond matures in 2019.

It is not easy to compare this bond with other Tesco bonds that are currently on the market, as these are fixed-income bonds.  However, it does provide an opportunity to revisit a question that all investors should ask; whether to be an owner or a lender.  This could relate to asset classes in general, or to individual shares and bonds, and I am highlighting Tesco only as a topical example.

If you wish to lend money to Tesco, there are 3 fixed-income bonds on the market that can be bought by retail investors: -

07/12/2011.  All figures are gross, and do not include purchasing costs.  2018 bond is issued by Tesco PF; other bonds issued by Tesco plc.

Note that, as each of the issues currently trades above the ‘par’ value (100), the redemption yield is much lower than the fixed-income yield.  The redemption yield reflects the fact that the redemption proceeds will be less than the price paid, that is, the current price.

Of course, an alternative to lending money to Tesco, or anyone else, is to buy the company’s shares.  Owners of Tesco shares are owners of the company.  They benefit from dividends that the company pays in the form of income, and they also participate in any appreciation or depreciation of the share price.  Tesco shares currently have a dividend yield of around 4% p.a., which is roughly the same as the redemption yield on the bonds. The dividend can be increased or decreased, and will depend upon the performance of Tesco’s business.

Investment advice should always be sought before buying shares or bonds.