Liquidity lowdown: Why consider covered bonds?

Covered bonds have been a trusted financial instrument for centuries. Originating in Prussia in 1769, they are backed by a dynamic pool of high-quality assets — typically residential mortgages or public-sector loans — and issued by banks and mortgage institutions as a cost-effective way to raise funding.

What sets covered bonds apart is their dual recourse structure: if the issuer defaults, investors have a claim both on the issuer and the underlying asset pool. Remarkably, covered bonds have never defaulted in their long history. Under the Bank Recovery and Resolution Directive (BRRD), they are also exempt from bail-in, unlike unsecured debt instruments — making them a resilient risk management tool.

For investors like Royal London Asset Management, the security and reliability covered bonds offer can be invaluable, particularly in times of economic and political uncertainty. Recent events — including ongoing instability in France, the chaos following Liberation Day (April 2025), and the anticipation surrounding the UK’s November budget — have only reinforced their appeal.

Market dynamics and investor appetite

Investor demand remains strong. After a typical summer slowdown, sterling issuance surged in September, already exceeding 2024’s full-year total by an estimated £1.1bn — with 10 weeks still to go. This uptick is partly driven by increased mortgage activity, as central banks cut rates and mortgage costs fall.

Covered bond spreads ended 2024 near record wides, following a period of tightening earlier in the year when issuance slowed. This widening made them particularly attractive to real money investors, who typically buy and hold until maturity. In 2025, spreads have remained stable despite increased issuance, with some tightening seen in the second half of the year. Covered bonds continue to trade near their highs, reflecting strong market confidence.

Pricing and performance

Yields on covered bonds tend to align more closely with government debt and swap rates than with corporate bonds. Their pricing is influenced by monetary policy, regulatory frameworks, and broader macroeconomic conditions. Notably, almost every recent UK issuance has priced tighter than initial guidance — a clear sign of robust investor demand. Most new deals have been significantly oversubscribed.

Covered bonds remain a high-quality asset class and an ideal way to diversify away from corporates, particularly when spreads converge.

Why do covered bonds still matter?

In our view, covered bonds offer a rare combination of credit exposure without default risk, strong legal protections, and high liquidity — especially in shorter tenors. They remain a high-quality asset class and an ideal way to diversify away from corporates, particularly when spreads converge.

We believe their appeal will persist well into the foreseeable future, continuing to serve as a cornerstone of portfolio stability and strategic allocation.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.