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Alternative Investments

How Risky Are Mini Bonds as FCA Bans Firm?

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IPM, an FCA-regulated firm that approved the promotional materials advertising mini bonds to retail investors has been ordered by the financial regulator to immediately cease all regulated activity. The ban comes after 2 companies that issued mini bonds marketed through advertising approved by IPM collapsed, with investors losing at total of £15 million. £7 million worth of mini bonds were issued by Secured Energy Bonds, which failed in 2015, and £8 million by Providence Bonds, which similarly went under a year later in 2016.

If the promotional materials issued by either company had not been approved by International Portfolio Managers, they would not have been allowed to be marketed to private investors. The administrators of the two failed companies had informed investors that there was little chance that any assets would be recoverable and that in all likelihood, they had lost the entirety of their investment.

When investors initially complained to the Financial Ombudsman, they were informed that because mini bonds are not a regulated product it did not fall under their jurisdiction. However, it was argued that because marketing materials had been approved by IPM, a regulated firm, to be marketed to the general public, there was a case against IPM. The ombudsman reversed its initial decision and passed the case over to the FCA who has now told IPM to immediately cease of regulated business operations.

The case raises the larger question of how safe mini bonds generally are as an asset class and whether private investors should ever consider investing in them. Retail bonds, the big brother of mini bonds, are IOUs issued by major companies as a way to raise money to invest in the business. They are listed on the stock exchange and as well as paying a fixed interest, or ‘coupon’, their value also fluctuates.

At the end of the bond’s lifetime, which can be anything between 2 and 20+ years, though the usual is 5-10, the investor receives back their initial investment. In the meanwhile, they have received the fixed income guaranteed by the bond. Funds are not protected by the Financial Services Compensation Scheme like cash bonds issued by banks and building societies but as long as the issuing company doesn’t go bankrupt in the meanwhile, there should be no issue in the investor getting back their original investment at the end of the bond’s lifetime.

Retail bonds became popular after the London Stock Exchange launched their listing service in 2010, with investors looking for relatively low risk alternatives to bank deposits paying next to no interest.

However, mini bonds are not listed on the stock exchange and are therefore neither a regulated product nor is there a liquid market to subsequently sell them before they reach maturity. There have been several high-profile mini bond launches in recent years, with some of the big start-up crowdfunding sites such as Crowdcube and Funding Circle promoting them. Companies such as the Scottish hipster beer company Brewdog, valued at over £1 billion earlier this year is among the companies that have had mini bond offerings that proved successful for both the company and investors.

However, for all of the success stories there are also several companies that have issued mini bonds and subsequently gone under. In this circumstance, mini bond holders are very likely to lose all of their investment.

Mini bonds are generally offered by younger companies in a growth phase and assessing the stability and future prospects of this kind of company is something that many private investors lack the experience to do. And the fact is that companies in this development stage are high risk.

Mini bond investors fall into two categories: high net worth individuals who are experienced in assessing a company’s prospects and understand the risk they are taking and less experienced private investors seduced by the headline returns and marketing materials. Investing in mini bonds can be profitable but it is also high risk.

Smaller investors who like the look of a company issuing mini bonds may well wish to make an investment in the company’s future by buying some, and there is nothing wrong with that. However, they should do so on the understanding it is a high risk venture and invest only smaller sums they are prepared to potentially lose if things don’t work out as hoped.

Risk Warning:

Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.

There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

Paul

The author Paul