A guide to mini bonds
Afraid of complicated investment products? Don't worry, these are mini! None of those pesky consumer protections or secondary markets, or other complicated bits that take time and concentration to wade through - on which more later.
On the other hand, they are interesting propositions. In many cases, they promise payouts set to beat what might be considered good returns in an equity fund. And if you are really into a certain product or hobby - horse racing, chocolate or boutique hotels, for example - they can be a pleasant way to play with one corner of your portfolio.
Mini bonds are like the unruly younger brothers of relatively sensible retail bonds. Retail bonds give investors a direct path to corporate debt opportunities, freeing them from having to seek access via a corporate bond fund that buys wholesale.
Most of the institutional bonds issued by companies have minimum investment requirements in the hundreds of thousands of pounds, effectively ruling them out as individual holdings for everyday investors.
Retail bonds emerged to fill this gap in the corporate bond market. They usually require a minimum investment of between £100 and £1,000 and list on the London Stock Exchange's Order Book for Retail Bonds (ORB).
When we last wrote about retail bonds, we reported that although investor enthusiasm was high, issuance was slowing down. Only six companies had launched retail bonds in the year to June 2014, compared with 16 in the previous 12 months. That trend seems to have continued: only five retail bonds listed in the 12 months to 1 March 2015, compared with nine in the previous year.
The average issue size has also fallen, from £104 million in the 12 months to March 2014 to £80.2 million in the following year. This reduction in average size is partly due to one particularly small listing - the £11 million Retail Charity Bonds (RCB) - and the small bond pool. Excluding RCB, the average issue size was £94 million, still a slight drop.
Mini bonds are a more recent arrival. By foregoing trading on an exchange - and by paying part of the coupon in their own product in some cases - companies can avoid some of the costs of issuing a retail bond.
With the Bank of England now having held interest rates at rock-bottom levels for six years, Adrian Lowcock, head of investing at Axa Wealth, says the rise in mini bonds is a symptom of the hunt for income. “I think they often tried to appeal to savers looking for something more than cash, which was paying below-inflation rates,” he explains. “These bonds often looked like secure alternatives, [although] they are actually higher-risk alternatives.”
James Tomlins, manager of M&G's Global High Yield Bond fund and European High Yield Bond fund, adds that the popularity of mini bonds is the result of a confluence of factors: investors' continuing hunt for income has coincided with banks' greater reluctance to lend to higher-risk businesses.
Quirkier examples of mini bond issues include The Jockey Club's Racecourse bond, which pays 7.75% a year over five years, split between 4.75% cash and 3% in loyalty scheme points; the Hotel Chocolat bond, which lets investors choose between an annual return of 7.25% of in-store credit or 7.33% in the form of a monthly box of chocolates; and the Mr and Mrs Smith bond, in which investors choose between 7.5% a year for four years or 9.5% in points with the boutique hotel chain's loyalty scheme.
One bizarre example is the Chilango bond, paid out partly in burritos from Chilango restaurants.
“[The appeal of mini bonds] is a high fixed income, a capital return at the end of the bond's life, discounts and loyalty offerings for bondholders, and options to convert the bonds into payouts in goods and services,” says Lowcock. “You get to invest in a company you really like and are a customer of.”
Of course, there are drawbacks. The most obvious is the potential for capital loss: because mini bonds are usually issued by individual relatively small or new companies, they make quite risky investments. This is fine as long as you are happy to take on that risk, but it could be easy to find yourself with your eggs in too few baskets if you are relying on mini bonds for returns.
However, Tomlins warns: “A lot of practices in this market fall far short of what we would expect from the institutional bond market. The level of disclosure you get is pretty limited. You can have a prospectus that is four or five pages long and very shiny, but pretty minimal in terms of financial information.”
In the balance
Lowcock adds that investors really should understand the business's balance sheet before investing, to get an idea of how likely the company is to succeed. Early 2015 saw the first mini bond default, when bonds issued by Secured Energy Bonds stopped paying interest, leaving investors wondering if they would ever see their money again.
Investors should also consider the fact that there is no secondary market for mini bonds. Once you buy a mini bond, you're stuck with it until the end of the bond's life, typically five or six years.
But there are two particularly important drawbacks to be aware of. The first is the lack of investor protection. Too often the company issuing the bond doesn't make clear exactly what assets investors are lending against, or where in the queue of clamouring creditors they will be if the company subsequently becomes insolvent.
Moreover, mini bonds can be bought back by the issuing company at parity before the term ends, perhaps if the company decides it no longer wants to pay out a coupon to investors or finds better financing elsewhere.
This may sound technical, but it's an important detail: with institutional bonds, in contrast, if the company wants to buy them back early, it has to pay a higher price. This ensures that investors will get a bit of an uplift, even if the bonds don't run to term, and that there are two ways to profit from investing.
Tomlins says this means that while bondholders share all the potential downside - losing their investment if a firm goes bust - they aren't guaranteed to enjoy all the potential upside.
The second drawback is what Tomlins calls a “disconnect” between the level of risk taken on by a mini bond investor and the potential returns. Even payouts approaching 10%, he says, would not be enough to convince an institutional bond fund to invest.
Considering that the companies involved are unproven start-ups, it would take payouts of three times that size to convince big-time investors to take on the risk entailed in investing in such companies.
However, he adds that there is a place for these high-risk investments if you can afford to lose your capital and don't mind living with that level of risk.
So who should invest in them?
“Loyal customers who know the business and business owners well and are willing to take the risk,” says Lowcock. “[They are] not suitable for [cautious] investors looking for an alternative to cash.”
However, considering that it has been persistent low interest rates that have contributed to the rise in popularity of mini bonds, one has to wonder if they are being bought by the right kind of investor, or if investors are perhaps taking on more risk than they realise in an effort to boost their income and beat inflation.
Sample mini bonds available
Rectory Homes Bond
A five-year fixed-term bond paying 6.25% gross a year issued by property developer Rectory Homes to fund building homes.
Wellesley Mini Bond
Available for three-, four- or five-year terms and paying 6, 6.5 and 7% gross respectively in biannual instalments, issued by peer-to-peer lender Wellesley & Co 0800 888 6001.
At the time of going to press, no new retail bond issues were available on ORB. However, you can view all current listings by visiting ORB's website.
Mini bonds: for and against
Low minimum investment
High risk of default
Lack of transparency
Imbalanced downside and upside exposure
Lack of investor protection
Not covered by Financial Services Compensation Scheme
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
A document which describes and advertises a new share issue or flotation (IPO in US) to potential investors, the contents of which are regulated by UK company law, the Financial Services Authority (FSA) and the London Stock Exchange. The prospectus should include details such as a description of the company’s business, financial statements, biographies of executives and directors, detailed information about their remuneration, any current litigation, a list of assets and other information deemed relevant for consideration by a prospective investor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
A property chain is a line of buyers and sellers (the “links”) who are all simultaneously involved in linked property transactions. When one transaction falls through – for instance, someone can’t get a mortgage or simply withdraws their property from sale, the entire chain breaks and all the transactions are held up or even fail entirely.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.