News

7th Jun

Caveat Emptor – Mr Bond urges caution when purchasing retail bonds

Investors tempted by the 7.5% offered by the ‘retail bond’ currently being presented by CBD Energy may be left wishing they’d read the small print when they realise that they are tied into a four year investment that is not covered by the Financial Services Compensation Scheme (FSCS), cannot be traded in the secondary market and attracts tax on the interest it pays. 

Australian renewable energy company CBD Energy, which comes replete with the endorsement of no less a figure than US ‘royalty’ Bobby Kennedy, already has solar and wind installations in Europe and is seeking to raise money to fund UK expansion. 

However, Retail Bond Expert (RBE) urges that retail investors should do their homework to ensure that they fully understand the risks they are exposed to before they subscribe. 

Since Hotel Chocolat raised over £4 million in 2010 by rewarding those lending £2000 with a ‘bounty’ of six boxes of chocolates per year, there have been a whole raft of ‘loyalty bonds’ from companies such as John Lewis and latterly organisations such as The Jockey Club tempting investors with a range of non-financial rewards. 

When the retail value of the incentives are considered, these bonds can be seen to be offering a reasonable rate of return, and may be of particular interest to existing customers of the issuer. 

Mr Bond says... "we are committed to ensuring that investors have sufficient and transparent information before making any investment decision."

However, RBE is committed to ensuring that retail investors have sufficient and transparent information before making any investment decision and is concerned that terms such as loyalty bonds, private placings, cash bonds and mini-bonds are being used interchangeably, and increasingly collectively described as ‘retail bonds’ despite the fact that they may vary greatly in terms of their debt structure, protections and risk profiles.  

"we are concerned that terms such as loyalty bonds, private placings, cash bonds and mini-bonds are being used interchangeably, and increasingly collectively described as ‘retail bonds’ despite the fact that they may vary greatly in terms of their debt structure, protections and risk profiles" – Mr Bond

As reported on RBE on 16th May, Nuffield Health launched a bond paying 6% a year on deposits of as little as £1,000.   

However, the launch was met with a mixed reaction, with advisers in particular voicing concerns over the ability of retail investors to make informed choices and understand the risks that such investments may expose them to. 

By purchasing these bonds, the investor is effectively lending the issuer money which it will in turn use to develop its business; the return of the loan is dependent upon the issuer remaining in business at the date of maturity, and should that not be the case, there is no recourse for the investor to the FSCS. 

A key consideration in this instance is the duration of the bond which at just five years means that it is ineligible to be wrapped into a tax-free individual savings account. Instead, savers will have basic rate tax of 20% deducted from the interest payout at source meaning that savers will receive 4.8% interest. 

Taxable or Non-taxable?

If the purchaser is a non-taxpayer, they can reclaim the tax, or if they are higher rate taxpayers they will have to declare the income and pay the balance returning an effective rate of just 3.6% - virtually halving the attention-grabbing headline yield. 

Advisers have warned that despite the large sums that have been raised by companies on the Order Book for Retail Bonds (ORB), retail bonds should not be seen as a safe, high-yield option, and point to the recent slump in bonds in the Cooperative Bank which fell 40% following a downgrade by Moody’s. 

Further concern was expressed at the fact that the Nuffield bond will not be traded in the secondary market thereby locking investors in for the entire five years.  

"The Nuffield issue underlines the importance of investors understanding what they are buying because there are important differences between this and some of the recent retail bond launches" – Kevin Doran

As recently reported in Money Observer, Kevin Doran from private bank Brown & Shipley "The Nuffield issue underlines the importance of investors understanding what they are buying because there are important differences between this and some of the recent retail bond launches”  

He added, "The Nuffield Health bond won't be listed on the London Stock Exchange, where retail investors can trade bonds in a similar way to equities, and that means there will be no secondary market and no pricing once the issue goes live. He continued, "Investors have to ask themselves whether they think a yield of 6% from a not-for-profit organisation running hospitals and health clubs is sufficient. They should also consider whether they want to tie their money up for five years at that yield." 

He describes Nuffield's balance sheet as "not the best in the world", and says that although it had a turnover last year of £645m and fixed assets of £523m, it only managed to achieve a pre-tax profit of £4m. However, Nuffield says its turnover was up 12% on the year before, and return on capital employed rose to 15.7%. 

Whilst the Nuffield offer clearly differs in a number of respects from some of the bonds that have been issued on ORB, investors have clearly been tempted by attractive coupon rates, particularly as the yield on multinationals and utilities bonds are at historically low levels; execution only stockbroker Selftrade confirms that its share of each offer to date has shown a direct correlation to the yield on offer – its clients apparently oblivious to, or not deterred by, the risks attached. 

Doran rates less well-known companies such as Workspace, Unite and Enquest, which yield around 5%, but are backed by real assets such as property, or, in Enquest's case, oil flows. 

Calling For Defined Terms

Investors are advised to compare the "running yield", which is a snapshot of the current price of the bond compared with the interest paid, and the "gross redemption yield", which shows you how much you'll earn if you hold it to maturity.   

In order to ensure that investors have access to all relevant information and are able to make objective comparisons between issues, RBE is calling for clearly defined terms to describe the various product types currently described as ‘retail bonds’ with industry-wide agreement. 

It is also calling for those issuing and placing retail bonds to agree to and adopt a standardised format for a key information document to allow an ‘apples and apples’ appraisal of each opportunity. 

RBE believes that access to good information and education is key to making more investors aware of retail bonds and empower them to make informed investment decisions, which can only be a positive thing for all involved in the sector.    

As ever, RBE would welcome your feedback and encourages you to share these thoughts and join the debate.      

Ani

Posted on 20/10/2013 02:41:41

In addition to the froacts already alluded to by others, bear in mind the effects of inflation. While the yields of the bonds will not change for you if you hold the bonds to maturity, the purchasing power of those amounts will be affected by the changing cost of living especially if your plan involves bonds with many years to maturity. (Just a thought that should not be overlooked.)

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