Tesco has launched a new inflation-linked retail bond issue, which aims to provide protection against rising living costs.
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.