Many crowdfunding platforms have begun to offer mini bonds, an alternative way for businesses to secure debt-based finance. Whilst they advertise an attractive interest rate, there are many aspects that make them different to traditional bonds and therefore, ultimately, a riskier choice for investors.
This new craze in alternative finance had spawned many success stories – River Cottage, Hugh Fearnley-Whittingstall’s cookery business, drummed up £1m in just 36 hours. Investment in mini-bonds is a tempting prospect – they promise a good return, the opportunity to get the money back on a set date and a few extra incentives (free burritos anyone? That’s what people putting money into a bond by Chilango, the London-based Mexican food chain, received.)
So what are the pros?
Firstly, the yield is much higher than anything offered by banks, or traditional corporate bonds. Most mini-bonds offer around a 7%-8% interest rate, either in cash or rewards. Like Chilango, Hotel Chocolat followed the rewards method and paid their investors a 7.33% annual return in chocolate – little incentives like these make putting money into mini-bonds a fun, niche way of diversifying your portfolio. From the business’ point of view, offering non-monetary rewards such as these create a strong bond with the customer and hopefully build up a good client base which will be beneficial for business.
Another advantage that they have on corporate bonds is value for money. With corporate, the money is accessed through a fund run by a manager, who invests the money into different companies. Though this spreads the risk considerably more than a mini-bond, investors will have to pay fees to the manager that will detract from the return on the bond; with mini-bonds, the money goes direct to the company and cuts out the fund manager aspect, making it a cheaper option.
So far, so good. Or is it?
“These bonds often look secure, but they are actually higher-risk alternatives.” James Tomlins, manager of M&G’s Global High Yield Bond fund and European High Yield Bond fund warns. Mini-bonds constitute a far higher risk than traditional bonds. They are often compared to retail bonds, which were launched on the LSE in 2010; however, unlike these, mini bonds are not traded and there is no secondary market for them. Because of this, investors have no choice but to wait for the bond to mature before getting their capital back, which is usually around 5 years. Similarly, they are not subject to the same scrutiny and analysis as retail bonds, which are examined by legal and financial experts before becoming available.
Mini bonds also have a greater chance of default than other bonds; government bonds imparticular are far more secure. In early 2015 the first mini bond defaulted; bonds issued by Secured Energy Bonds stopped paying interest, eaving investors out of pocket. Furthermore, unlike most bonds, mini bonds can’t be held in an ISA; although they can be held in a SIPP.
Essentially, mini bonds constitute pretty unchartered territory. Tomlins continues: “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.”
Mini bonds can be an excellent choice; as long as you’re savvy about it. Putting all your capital into one investment is never a good idea, but diversify your portfolio with one or two mini bonds and you could find yourself could reaping good rewards.