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Severn Trent is to issue up to £100m-worth of RPI-linked bonds to take advantage of UK savers’ demand for inflation-proof returns and diversify into “cheaper” sources of funding.

The FTSE 100 water and sewerage group, which serves 4.2m homes in the Midlands and mid-Wales, announced the launch of a 10-year sterling bond, offering a 1.3 per cent annual coupon and a repayment of capital that will both rise in line with the retail prices index. Unlike its previous index-linked issues, however, the 10-year bond will be offered via eight private-client stockbrokers in minimum tranches of £2,000.

In issuing an index-linked bond specifically for the retail market, Severn Trent has become the fifth UK company to identify savers seeking a real return on cash as a source of cost-effective funding.

Last September, National Grid offered a 10-year RPI-linked issue that attracted more than £282m from private investors in an offer that was twice extended to meet demand. A month later, Tesco Bank raised £60m with an eight-year issue. Earlier this year, social housing group Places For People secured £40m through its first inflation-linked bond. RBS issued the first index-linked retail bond in 2010.

Mike McKeon, Severn Trent’s chief financial officer, said that the group would cap its first retail issue at £100m, but return to the market annually if it proved successful.

“We don’t want to tap out the market if want to come back in a year or 18 months,” he said.

Although the retail bonds will comprise a small fraction of Severn Trent’s £4bn net debt, Mr McKeon said that this form of funding could become more substantial in future. “If we raise £50m-£100m a year over five years and beyond, it could be 10-20 per cent,” he said. “Overall, the economic cost it is cheaper for us. It’s not attractive to offer coupon of 5 per cent, as we can already borrow cheaper than that. But an RPI-linked issue is attractive for us terms of cash flow.”

KPMG, which advised on the issue, claimed that more companies would turn to the retail market in future. “This will provide important alternative funding options for borrowers, especially as the bank debt markets look likely to remain under some stress in the future,” said partner Clive Gibbard.

However, financial advisers warned that individual retail bonds exposed savers to additional credit risk. Severn Trent’s bond is being issued by the plc, not its regulated water business, so investors are not protected by regulatory “ringfencing” of capital. It is expected to be rated investment grade Baa1 by Moody’s and BBB- by Standard & Poor’s, but Canaccord analysts noted that National Grid’s RPI-linked issue currently offers higher yield from a higher rated issuer.

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