25th Sep

The Tortoise and the Hare – but not a SIPP of Wine

Retail Bond Expert confirms the need for caution as borrowers tempt investors with a whole range of both listed and unlisted bonds, and asks if it is time for industry standard product definitions.


Consensus among industry participants at February’s celebration of the third anniversary of the Order Book for Retail Bonds (Celebrating Three Years of ORB and £3bn of Funding – Retail Bond Expert February 12th) was that issuance this year would at the very least match that of 2012.

However, despite the fact that interest rates remain historically low, a combination of factors including the success of the government’s Funding for Lending scheme, robust equity markets and improved gilt yields have conspired to ensure that issues on ORB in 2013 have been disappointingly scarce.

Despite the dearth of bona fide retail bonds, all the time there are companies looking for alternative sources of funding and investors looking for value, it appears that there will always be innovative and imaginative products available to unite the two.

Understanding the Risk

As ever, where there are opportunities there are risks, and Retail Bond Expert urges would-be investors to ensure that they know and accept the risk attached to any bond before they take the plunge – failure to do so, could see them tied into an illiquid product rendered unattractive by shifting economic conditions, with erosion of capital the penalty for an early exit.

Becoming increasingly popular, crowdfunding – raising money from small investors to finance business ventures – is a recent solution, and one that allows investors to take a ‘punt’ on a range of propositions in the hope that one will make it big and mitigate losses on the majority that are likely to fall short.

Mr Bond says... "The reward for each retail bond is clear, the risk however is complex and difficult to assess. Now is the time to grade these types of investment"

However, such investments are unlikely to form the cornerstone of a long term investment strategy and the level of confusion and uncertainly that currently exists amongst products that are interchangeably tagged as ‘retail bonds’ serves neither the industry nor the investor well.

There are of course common traits – bonds are issued where one party borrows money from another and pays them an agreed fee for the privilege.

When HM’s Government borrows money it issues the safest form of debt security, gilt edged bonds - Gilts – secured against the fiscal fabric of Albion and as safe and dependable as the Old Lady herself.

However, the bewildering array of products appearing under the collective moniker of ‘bonds’ includes, inter alia, mini-bonds, loyalty bonds, corporate bonds, re-packs, convertibles and retail bonds – each coming with its unique combination of risk and reward.

A ten year German Bund not gamey enough for you at 1.85%? (Sept 24th) maybe you’d prefer 10.33% from Greek treasuries? That 27% unemployment rate can only go one way, surely?

If you need any further proof of the need for caution, Google ‘junk bonds’ and ‘credit crunch’.

As a rule of thumb, “retail bonds” describe those issued by typically large companies which are then traded on ORB – a part of the London Stock Exchange. Tesco Personal Finance, National Grid and the LSE itself have all issued retail bonds of this sort.

A retail bond is an IOU issued by a corporation to an investor. An investor lends the company money, and in return the company pays the debtor interest on that loan. These allow investors an exit if they need their cash during the bond’s term as there is a liquid secondary market and there are also higher standards of governance and disclosure associated with the bonds’ stock-market listing.

However, as Co-op Bank bondholders have recently discovered to their cost, these are not no-risk investments (‘The Only Way is Ethics – Co-op Bank Bond Holders Fight Bail-in’ Retail Bond Expert 27th August). A further danger is that retail bonds can be structured in ways which are difficult for unadvised, private investors to understand but which affect risk.

Index-Linked Bonds

Investors today can choose between a Morgan Stanley Index-Linked Bond guaranteeing RPI plus 0.6% p.a., a mini bond offered by Naked Wines offering 7% p.a. cash return or 10% if the investor accepts payment in wine credits, or a corporate bond issued by solar panel insurer A Shade Greener which offers to pay 18% up front representing the entire return on the bond for the duration of the loan.

Investors dazzled by the prospect of an eye-popping immediate return may repent at leisure over the three year duration of the product (recently variously described as a ‘retail bond’, a ‘corporate bond’ and a ‘mini bond’ in a single recent article in the Daily Telegraph) as they sweat in the hope that A Shade Greener has got its sums right and can repay its debts. And, on reflection, that 6% annual return doesn’t look as attractive as you enter it on your annual tax return, as its three year duration excludes it from being included in an ISA wrapper.

Naked Wines

Naked Wines’ mini-bond may be attractive to investors keen on taking advantage of a 10% return in wine credits, but the 7% cash on offer will be subject to tax and, in common with most mini bonds, there is no protection from the Financial Services Compensation Scheme.

Morgan Stanley’s product joins a group of index linked bonds available on ORB – ‘linkers’ in Bluffer’s parlance – and based upon an initial UK RPI figure of 247.60, according to Fixed Income Investor, the 0.6% the bond offers represents ‘marginal value’ when compared with other RPI linked products - Places for People 0.36%, National Grid 0.46%, Severn Trent 0.46% and Tesco with 0.50%.

Anything else to consider? Well, with its ten year duration, the Morgan Stanley bond is eligible for inclusion in a SIPP, SSAS or ISA, but those without a current W-8BEN in place will have US withholding tax deducted at source. Minimum investment - £500 or £1000; date to maturity three to ten years.

These are all factors that a would-be investor should take into consideration, and that’s before studying the historical performance and prospects of the company they are investigating, where the loan sits in the debt structure of the business, whether the bond is rated and what, if any, protection is on offer.

Generally speaking, mini bonds are not quoted on the London Stock Exchange, and any money committed is pretty much tied up until they mature. They are generally more dangerous than tradeable retail bonds, and often pay higher interest to reflect this risk.

Mini Bonds Conundrum

Mini bonds are at the speculative end of the bond spectrum, but may appeal to a loyal customer of a business who would view the non-cash incentives offered as a reward as a discount on goods and services they would purchase anyway. Alternatively they may be seen as a way of supporting a sports club or charity – but they should rarely be considered a reliable source of income.

However, with cash savings accounts no longer offering a real post-inflation return to savers, retail bonds have increased in popularity raising concerns that inexperienced investors were unaware of the risks of such investments - confusing retail bonds with cash bonds issued by a high-street bank or building society.

Unlike cash bond deposits, retail bonds are not covered by the Financial Services Compensation Scheme. The value of your investment can go down as well as up, although investors who bought at launch should have their initial deposit refunded in full as long as the company survives.

‘Retail Bonds have struck a chord with those investors who want to cut out the fund manager middle man and are generally content to hold a bond with a decent coupon through to maturity,’ said Jason Hollands of financial planners Bestinvest.

‘However, it is vital to know what you are doing as it is not as straightforward as being swayed by a well-known brand attached to the issuer and a juicy headline yield. These bonds are often owned by subsidiaries, so it is important to understand which bit of the business you are exposed to and where you will sit in the capital structure. This process has not been helped by the dearth of credit ratings.’

Investors should also take care not to confuse retail bonds and mini-bonds. Mini-bonds are not listed cannot be traded on the ORB, are illiquid and must be held to maturity.

Adrian Lowcock of stockbroker Hargreaves Lansdown said that unlike mini-bonds which need to be held until expiry some years later, retail bonds on the ORB can be bought and sold during normal market hours allowing investors the opportunity to both value and sell the bond.

"If only it was a simple as simply choosing a bond and investing, next decision is whether it should be housed more tax efficiently in a SIPP, SSAS or ISA. Not all bonds can appear in all of these savings products, again research is key"

‘Personal circumstances can change, so being able to sell your investment when you want and at a fair value should be paramount,’ said Lowcock.

‘The ORB has helped to provide essential liquidity to investors, but it also allows the bond to be held inside SIPP and ISA wrappers. I believe unlisted investments are inappropriate for the majority of retail investors. You are taking risks when lending your money to a company and I urge investors to think carefully about the suitability of mini-bonds before they buy.’

So, RPI + 0.6% for ten years, three year’s worth of most agreeable fine wine or a nigh-on 20% immediate return? Investors are being asked to make decisions based upon their long term predications on interest rates and future economic circumstances, and in a worst case scenario it may be that more than one of these products could end up going down the drain.

Retail Bond Expert echoes its call for would-be investors to ensure they understand the risk and restrictions that are attached to any product before they purchase it, and that if they are in any doubt, they should seek professional advice appropriate to their level of knowledge and investment experience.

Whilst individual investors may consider supporting a company for reasons of both heart and head and may be prepared to take on additional risk based upon their emotional attachment to a business or cause, it is significant that in most circumstances such products will not survive the due diligence conducted by wealth managers.

Having said that, if the experts always got it right, the City would be a very much smaller and less colourful institution and the ‘house-view’ would always be right; that does look a rather toothsome Montrachet..................................

Ian Pittaway

Posted on 25/09/2013 20:04:32

The absence of offers is really disappointing. I am keen to build a portfolio of bonds but there has been very little in recent months. Let's hope it picks up in the Autumn.

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