UK Debentures - A Comprehensive Guide for Investors

Jitanchandra Solanki Feb 10, 2025 14 Min read

This article dives into the complex world of debentures - a debt instrument without underlying collateral which is used for long-term financing of business operations or specific projects. While they play an important role in the financing of companies, some investors also use them as part of their portfolios.

Key Takeaways
Understanding Debentures in the UK
Debentures vs. Other Investments
Investment Opportunities in the UK
Conclusion

Key Takeaways

Debentures are unsecured debt instruments that allow companies to raise capital without directly giving away equity.
Interest rates, yield, maturities and credit ratings have a big effect on debentures.
Debentures yield higher returns than bonds because they face higher risks. In comparison to stocks, they yield lower returns.

Understanding Debentures in the UK

In this section we detail what debentures are, the different types available, how they differ from other asset classes and some of their key characteristics.

What are Debentures?

Debentures are types of debt instruments that are used to raise capital. A debenture is not backed by collateral or any other assets. To understand debentures the best, it is essential to understand the difference between debt and equity. Equity, like stocks, gives investors ownership of a part of the company. Debt on the other hand is raised without giving away any equity in the company. When investing in debt, money is lent to a company.

As a reward for providing this money, the company pays annual interest payments up until the moment the debt has been repaid. Debentures are considered medium to long-term investments, as they often have a repayment date of five to ten years. It implies that the company will pay back the principal payment at the end of that timeframe. Over the last few years, the returns on debentures have reached multi-year highs, after a significant drop, as highlighted in the chart below.

Source: Bank of England. A graph showing the average interest rate on unsecured loans in the UK.

Debenture Stock vs. Bonds

Bonds and Debentures are both debt instruments that are issued by either private companies or governments. They both pay fixed or variable interest rates annually. A big difference between the two investment vehicles is that debentures are not backed by collateral. This can be an advantage for companies because they can raise capital without having to put up collateral or give away equity.

Debentures are also often employed to finance particular projects, while bonds are for more general purposes. For investors, it introduces additional risk as in the case of bankruptcy of a company, there is a capital structure priority that decides who gets the residual money. When a company defaults, the debtholder of secured debt instruments gets their money first. Next in line are the unsecured debtholders and after that the equity holders.

Types of Debentures: Secured and Unsecured

There are two categories of debentures. The first includes unsecured debentures, which can be issued by companies or the government and have no collateral security. The second category includes secured debentures because of their collateral backing, which would more likely recover the investors' capital in case of company default. This implies that investors naturally would demand a higher return to cover a portion of the risk involved in holding unsecured debentures.

Interest Rate and Yield

The annual interest rate serves as a reward for lending money to a company. The interest rates on debentures can either be fixed or variable. The yield represents the return on investment for an investor and is dependent on the interest rate, the maturity and the current price of the debenture.

Maturity Date and Issue Price

Debentures have maturity dates, which is the date the face value of the debenture is repaid to the investor. On this date, besides payment of the face value, the last interest payment is also made. It's important to note that the issue price differs from the face value of the debenture as it represents the true value of the security.

For example, let's say a debenture had a 2% fixed interest rate. When interest rates rise more than 2% in the broader market, the interest rate on the debenture doesn’t seem as lucrative anymore. This is because somewhere else in the market, you can get a higher interest rate for the same amount of risk. When this happens, the issue price of the bond falls below its face value. Therefore, there is an inverse correlation between price and yield as when the price drops, it increases the effective yield of the bond.

Security and Credit Rating

All types of debentures have credit ratings that represent their creditworthiness. Rating agencies like Moody’s, Fitch and S&P provide those credit ratings to give information about the default risk of companies. Having a clear insight into the risk of default allows investors to make a well-informed decision. Although credit rating agencies use different rating scales, all ratings with A are generally considered to have a high creditworthiness.

Source: The Association of Corporate Treasurers. Credit Rating Scales.

Debentures vs. Other Investments

In this section, we explore the similarities and differences between debentures and other investment products such as stocks and bonds.

Comparison with Stocks and Bonds

Different types of investment vehicles offer different returns associated with their own specific risk. In general, investment instruments with high risk may also offer higher returns. Lower-risk investments often offer lower returns. This is because investors require a higher amount of return for riskier investments as you can lose all your money in an investment.

Risk and Return Analysis

Stocks are considered to be a risky investment. The prices of stocks can be very volatile and are dependent on a set of variables you cannot predict. When companies perform well, the potential returns of their shares can be large.

However, when companies perform poorly, the losses can be very high, and you can lose your entire investment. Bonds, on the other hand, are known to be less risky than stocks - but not without risk entirely. Bondholders are paid back first, even before stockholders, in case of a company defaulting. The lower risk that is associated with bonds also means that investors get lower returns.

Debentures lie somewhere in between stocks and bonds on the risk scale. So, in general, they could provide higher returns than bonds, but they are also riskier.

Investment Strategies

Incorporating debentures into an investment portfolio can offer a degree of diversification. As seen in the chart below, investors tend to anticipate their investment strategies based on economic growth. The chart shows a drop in unsecured debt during the COVID-19 outbreak, as there was a higher chance of default during that time offering a lower probability of repayment.

Source: Bank of England via House of Commons Library. Change in outstanding levels of debt to individuals in the UK.

UK Companies Act 2006 and Debenture Stock

The debentures that are issued have to conform to regulations concerning disclosure and creation of charges under the Companies Act 2006. It describes a set of rules regarding financial markets. The last changes to the act were made in early 2024. They focused on economic crime and corporate transparency.

Financial Reporting Council (FRC) Disclosure Requirements

The Financial Reporting Council (FRC) aims to ensure that financial statements are transparent and reliable. Companies that make use of debentures have to disclose essential information like risks and interest payment obligations. The FRC enforces accounting and financial reporting standards and ensures that companies provide accurate information.

For companies that use debentures, the FRC requires disclosure of terms like interest rates and maturity dates. Furthermore, the FRC ensures that audits are done accurately and that companies have strong corporate governance practices. Additionally, the FRC ensures that audits are done accurately, and that companies have strong corporate governance practices.

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Investment Opportunities in the UK

In this section, we explore the different investment opportunities relating to debentures available to UK investors.

London Stock Exchange (LSE) Listings

Many UK investors may already be familiar with the London Stock Exchange (LSE) which facilitates the trading of shares of public companies in the UK. It acts as a secondary market where investors can buy and sell equity in these companies. The expected market value must exceed £30 million for shares to be listed on the LSE. The supply and demand of these shares from investors determines the market price.

Bonds are also exchanged and issued on the London Stock Exchange. LSE is the biggest regulated market for bond issuances. For bonds, the requirements to be listed at the LSE are a total market value of £200,000. Settlements of bonds often happen through the CREST system, which is used in the UK and Ireland for settling payments.

UK Government Bonds (Gilts) and Yield Curve

The yield curve is an important indicator to understand the state of the UK's financial markets and also influences monetary policy. The yield curve shows the interest rates of bonds with similar risks but different maturities.

Typically, it is upward-sloping as longer maturity brings higher risks. When inflation rises it often pushes yields up because investors require higher returns for the loss of purchasing power caused by inflation.

When central banks raise short-term interest rates to try and cool inflation, short-term bond yields can exceed long-term yields. This can result in an inverted yield curve, which economic theory suggests is a sign that an economy may head towards a recession. However, even though many central banks raised interest rates globally to control the increased inflation between 2021 and 2023, the inversion of the yield curve did not lead to a recession.

Source: Statista. Partially inverted yield curve in the UK.

Investment Banks and Debt Capital Markets

Investment banks play an essential role in debt capital markets such as debentures. As opposed to commercial banks, investment banks do not provide loans to individuals. They can underwrite debt and equity to bigger corporations that help them finance their operations.

Debt instruments like bonds and debentures are a big part of the financing process of a company. Merger and acquisition (M&A) deals often consist of a certain amount of debt financing. This allows companies to raise capital without giving away equity in the company.

Credit Rating Agencies and Investment Grade

Credit rating agencies such as Moody's, S&P and Fitch provide several rating scales that give insight into the creditworthiness of a company. It gives investors insight into what extent an investment is risky.

When assessing the creditworthiness of a company it is important to know what ratings are good. All ratings with multiple A’s or A+’s can be considered strong. Companies with B ratings have an intermediate risk of default while companies with a C or even a D have very low creditworthiness.

Investing in Bond ETFs

For most retail investors, investing directly into debentures is difficult. An alternative option to gain exposure to debt instruments is through bond ETFs. A bond ETF, or exchange-traded fund, is one investment product that holds a basket of different bonds and can be traded like regular shares as they are listed on stock exchanges. This way the investor can gain broad exposure to many different bonds, through just one single investment.

With the Admiral Markets Invest.MT5 account, there are over 30 bond ETFs from around the world that UK investors have access to. These include:

In fact, UK investors can access over 4,500 stocks and ETFs from some of the largest stock exchanges in the world, with the following commissions:

UK stocks and ETFs – 0.1% of trade value, 1 GBP minimum commission.
US stocks and ETFs – From $0.02 per share, 1 USD minimum commission.
France/Germany stocks and ETFs - 0.1% of trade value, 1 EUR minimum commission.

You can learn more about investing commissions on the Admiral Markets Contract Specification page. You can search for global stocks and ETFs from the Admiral Markets MT5 web platform and invest in four steps:

Open an account with Admiral Markets.
Click on Trade on one of your live or demo trading accounts to open the web platform.
Search for your symbol at the top of the search window.
Click Create New Order in the bottom window to open a trading ticket to input your trade size, stop loss and take profit level.

Source: Example of a chart and trading ticket from the Admiral Markets MT5 WebTrader platform. Illustrative purposes only. Date captured: 10 February 2025.

Conclusion

Debentures are a useful but not very well-known instrument within the UK investment landscape. They allow companies to raise capital without diluting equity. Because they have no underlying collateral, debentures are riskier than regular bonds. This could result in higher returns on debentures compared to bonds but with more risk.

However, for many retail investors accessing debt products like debentures can be challenging. An alternative is to invest in bond ETFs which are single investment products that trade on stock exchanges and can be bought like regular shares. As the ETF holds a basket of different debt-related bonds, it provides the investor with broader exposure.