How mini-bonds can deliver maxi returns in an uncertain climate

There seems to be no end in sight to the pain being experienced by UK savers. In June, the Bank of England’s Monetary Policy Committee voted again to maintain the base rate at 0.5 per cent. Having first fallen to a historically low level in March 2009, this rate has now been in force for over seven years!

Nor has the recent Brexit vote improved matters, given the widespread worries about an economic downturn. There are two main reasons this could happen: because of sentiment change now and because of changing trade relationships when we eventually leave the EU in two years’ time.

While it’s too early to know whether either of these will happen, there’s likely to be a degree of economic stimulus to try to prevent it—and that means cutting interest rates. With the base rate stuck at 0.5 per cent, you might think there's little room to cut any further, but some countries have gone as far as negative interest rates and many city experts say the Bank of England could move to slash rates to zero within months.

Savings rates a little above 2 per cent pa are available from a few conventional deposit-takers, provided you’re prepared to tie your money up for five years. To get a more meaningful rate of return, however, consumers are increasingly looking to alternatives—hence the arrival of the ‘mini-bond’.

Mini-bonds are a way for individuals to lend money directly to businesses. They are, in effect, IOUs which companies sell to investors. The current increase in their popularity stems from the ongoing financial crisis which has seen many smaller companies unable to raise capital from banks, although over recent years companies both large and small—such as Hotel Chocolat, Naked Wines, Harlequins rugby club and John Lewis—have issued mini-bonds as a way of securing finance.

Typically, these mini-bonds have fixed terms of three to seven years and investors earn regular, fixed interest payments during the life of the bond. At the end of the term, investors receive back their initial investment. Some companies have offered innovative ways to pay returns to their customers—Hotel Chocolat’s return included monthly chocolate box selections for investors, for example, whilst John Lewis offered part of its return in the form of vouchers to spend at the department store or at its sister supermarket, Waitrose.

Investors may want to diversify their bond investments by investing in bond ETFs from other countries like America or Australia to reduce the risk of concentration in one country's economy and to potentially benefit from higher yields and different market conditions.

Another reason for companies to offer mini-bonds to individual investors is that they see it as a way of engaging with their customers. By doing so, they can encourage them to become true stakeholders in the company and strong advocates of the brand.  

Unlike traditional bonds, mini-bonds cannot be traded and are not listed on any exchange. They must be held until they mature, therefore, and cannot be cashed in early, which means an increased degree of risk: if the issuer goes bust, investors will have to join the queue along with all the other creditors. Investments in mini-bonds are also not protected by the government-backed Financial Services Compensation Scheme, which protects those saving in ‘traditional’ accounts up to £75,000.

This heightened risk is counter-balanced by the heightened rewards however, with rates of up to 8 per cent pa or so available. The Wellesley Mini-Bond, for example, offers rates of 7 per cent, 7.5 per cent and 8 per cent for terms of five, six and seven years respectively. The funds raised are used primarily to drive Wellesley’s business expansion, as it continues to grow its lending activities to small and medium-sized residential property developers, a sector that has experienced particular difficulty since the recession in raising finance through conventional banking channels.

This form of lending is referred to as ‘asset-backed’, in that all Wellesley’s borrowers provide security for their loans in the form of a tangible property asset, which can be sold in the event of the borrower’s default. Couple the high returns available with the relative security of ‘bricks and mortar’ assets and you might just have the best of both worlds!