The pros and cons of mini-bonds

The pros and cons of mini-bonds

Corporate bonds are an ‘IOU’ issued by a company to an institutional investor.

The high level of initial investment involved – as much as £1m in the case of FTSE 100 companies – means they are not suitable for individual investors to buy.

Depending on the risk involved, the borrower (the company) will pay the lender (the investor) a rate of interest.

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The higher the risk of the company not paying back the loan, the higher the rate of interest.

This payment is called a coupon, and the interest rate is also referred to as the yield.

Key Points

  • Mini-bonds are a loan issued directly by the issuer to individual investors.
  • The 'Burrito Bond' raised £1m in a few days and the appeal is the higher rate of interest on offer.
  • Mini-bonds are considered high risk and are not subject to a lot of regulation or protected by the FSCS.

Bonds will have a set term and a maturity date on which the capital is repaid.

Large, established companies issue bonds through the stock market to raise money to pay for expansion, mergers and acquisitions, share buy-backs or dividends.

These bonds can then be traded on the Order book for Retail Bonds between institutional investors, such as fixed income fund managers.

How the stock market values them will change depending on the yield they offer, the current interest rate market and when the maturity date is.

What is a mini-bond?

Less-established companies too small to be of interest to institutional investors may issue what is known as a mini-bond to raise money.

This is a loan directly between the issuer and individual investor, and requires a far smaller initial investment.

Because they cannot be traded between third parties they are considered illiquid assets – you are locked in until the bond matures.

Mini-bonds often offer a higher rate of interest than corporate bonds – attractive in today’s market where income is hard to come by.

FTSE 100-listed telecoms firm Vodafone issued a corporate bond in 2017, which is due to mature in 2025, paying an annual interest rate of just 1.125 per cent.

You can get a little more interest if you invest in a company with a lower credit rating, meaning there is a slightly higher risk of default.

The iBoxx Investment Grade Sterling Corporate Bond index is paying out a 2.7 per cent yield – but that is before tax and fees, and inflation is running at 2 per cent, eroding the real rate of income.

But last October, Mexican fast food restaurant Chilango issued a mini-bond yielding 8 per cent.

Dubbed the ‘Burrito Bond’, the term was four years and required a minimum investment of four years.

The bond was so popular it raised £1m in just a few days.

One of the quirks of mini-bonds is they often come with added extras – the Burrito Bond, for example, offered investors free burritos and guacamole if they invested.

In 2015, Taylor Street Baristas café launched a ‘Coffee Bond’, which offered an 8 per cent cash return or 12 per cent in-store credit for free fresh grounds, pastries and lattes.

What are the risks?

But as all investors know, you rarely get more reward without taking on more risk.