Mini bonds: a rewarding experience?

Tired of miserable interest rates? Looking to invest in a company you like that also offers a decent return? Then mini bonds could be the answer – but beware the risks

With the Bank of England base rate remaining at 0.5 per cent for more than seven years before being cut to 0.25 per cent in August, investors are understandably looking elsewhere for better returns. And in this low-interest rate environment, alternative investments such as mini bonds are attracting attention.

Put simply, a mini bond provides income via an agreed ‘coupon’, paid at regular intervals, which may be quarterly, half-yearly or annually, and at the end of the agreed term the investor’s capital is returned in full.      

Over the past few years, companies as diverse as Hotel Chocolat, Naked Wines, John Lewis, The Jockey Club and brewer Innis & Gunn, have issued mini bonds as a way of securing debt-based finance. Rather than approaching banks to finance anything from a new brewery to a new stand at Cheltenham, companies pay interest to people who love their product. It encourages brand loyalty and allows investors to play an important role in the future success of the business.

Mini bonds have also been used as a source of finance in the world of rugby. In May this year, Harlequins looked to raise £7.5 million via a mini bond by tempting fans with a 5.5 per cent interest rate paid every six months. The previous year, their bitter rivals Wasps launched a bond offering 6.5 per cent – the offer was oversubscribed and met its £35 million fundraising target within days.

Where's the catch?

With rates on offer from mini bonds typically ranging between six per cent to eight per cent (compare this with many bank or building society accounts, which are paying two per cent or lower), the obvious question is ‘sounds great, so where’s the catch?’. 
 
Whether you call it a catch or not, as Martin Bamford, Chartered Financial Planner with Informed Choice, points out, there’s a trade-off between risk and reward. “They’re definitely not cash savings accounts, so investors considering this option need to understand the risks involved,” he says. “The reason for the much higher interest rate on offer from mini bonds (than available from a cash deposit) is the additional risk to capital involved.”

Bamford explains that because mini bonds are often issued by relatively small or newly formed companies, the risk to capital is much higher than investing in corporate bonds. 

“The corporations issuing mini bonds are under less scrutiny than companies issuing corporate bonds, so investors can’t rely on the same amount of financial analysis or judgement about credit rating. Using the interest rates on offer as a guide, most mini bonds would be given ‘junk bond’ status and are very high risk.”

Mini bond investors also need to be aware of the fact that, unlike corporate and retail bonds, which are similar in nature but stock market listed, they get no protection from the Financial Services Compensation Scheme. This means that there’s no prospect of industry funded compensation should things go wrong.

Understanding the risks

And things do go wrong – in January 2015 we saw the first high-profile default, when the mini bonds issued by Secured Energy Bonds stopped paying interest to investors.

Such negative press coverage hasn’t served mini bonds well, but as Martin Belcher, Chairman at Polygon Group stresses, mini bonds serve a useful purpose for companies looking to raise finance, and to bond buyers too, as long as they understand the risks (and ideally the companies in which they are investing).

“For Channel Island investors there’s an opportunity to invest in local businesses through mini bonds,” Belcher explains. “They don’t feel they are investing from a distance and can take an interest in what a company does and in what it is achieving.”

He adds: “I would agree that the main motivation is fundraising but there’s the loyalty factor too, which is especially evident with those rugby club bonds. Investors feel part of the family and are supporting the development of their club.”

Polygon Group has a mini bond that enables the company to develop its property portfolio and investment broking business. “It’s not our principle way of raising finance,” Belcher says. “We intentionally keep it small (only ever around 20 per cent of funding) but it is useful. From our point of view, as a family business, we don’t want to sell shares so it’s a good way of raising finance.”

Investor caution

For the investor too, the onus is on keeping things small – not least because of level of risk and lack of liquidity. While minimum investments aren’t always high – Wellesley allows you to start with as little as £100 – mini bonds typically have minimum terms of three or more years, during which time investors are unable to get access to their capital (unlike listed equities and conventional bonds). In many cases, the return is a mix of cash and ‘perks’, which vary depending on the sector of the organisation issuing the mini bond (see right).

Mini bonds are a relatively new kid on the block, so it could be several years before we can judge their success. In light of this, should investors be putting money into mini bonds? And what percentage of their portfolio are we talking about? 

Bamford believes investors should tread carefully. “Any investor considering putting some money into mini bonds should have a healthy appetite for investment risk and, most importantly, the capacity for losses.”

Investors should only consider mini bonds if they have a real interest in the business involved – for example, rugby or horse racing, he adds. “Mini bonds should be viewed as an extension of a hobby in the first instance and as an investment second,” he says. “I wouldn’t advise a client to expose more than a few thousand pounds to mini bonds, so certainly nothing approaching a percentage of their overall investment portfolio.”

On the up?

Even if exposure to mini bonds is relatively conservative within a broader investment portfolio, with interest rates looking set to go lower, might mini bonds in general become more prevalent across the market? And will that in turn mean they get some protection?

Phil Lancaster, Investment Analyst at Lowes Financial Management, believes the popularity of mini bonds is likely to grow, but not radically. “There will be an increasing number of providers offering access to new opportunities, and investors who are investing capital they have the capacity to lose could potentially enjoy higher returns,” he explains. “The case for regulating the sector is well made, affording investors additional protection, but the cost would deter many small firms from raising much-needed finance.”   

Aldwyn Boscawen, Marketing Manager at UK mini bond provider Wellesley, agrees there’s been strong demand for mini bonds recently but says they’ll never be, nor were they designed to be, a mass market product. “Mini bonds shouldn’t be seen as an alternative to cash,” he says. “They’re very different in terms of the risk involved – an investment not a savings product.”

Consequently, Wellesley has introduced an online suitability questionnaire, which outlines the risks to potential investors taking into account their circumstances and net worth. 

Limited access

In terms of accessing mini bonds, Boscawen makes the point that availability is limited. “There aren’t that many mini bonds issued and they aren’t products available through the likes of Hargreaves Lansdown.”

Belcher at Polygon Group says there are two options for investors – they can either invest directly with the bond provider or via a lending platform such as CrowdCube, Syndicate Room or Independent Portfolio Managers. These platforms are mostly regulated by the Financial Conduct Authority and their role is to promote a company’s mini bond on a non-advised basis. 

The Polygon mini bond uses the direct option. They don’t market to the general public. Instead the company looks for investors from within their own contacts. 

Belcher agrees that mini bonds aren’t for everyone – but for those who understand the company issuing the bond and the risk versus reward trade-off, they can be an attractive addition to a broad investment portfolio.