Frozen Pension: Guilty secrets: My mini-bond portfolio

When The Accumulator opened his Investing Confession Booth a few years ago, I didn’t know where to look.

Having started my investing journey as a more or less passive investor, I’ve sinned, sinned, and sinned again.

Still, it’s all relative. My active investing exploits make sense to me, and whether or not they’d find my decisions advisable, investors like Warren Buffett or Neil Woodford would recognize what I was doing, were they unluckily enough to be trapped in a lift with me and my laptop.

However, I’ve also got what we might call ‘off-spreadsheet items’.

These assets are part of my net worth, but for various reasons I don’t include them in my tracked and benchmarked investment portfolio.

For instance, I’ve socked away a big chunk of cash for a house deposit. Who knows if I’ll ever buy my white elephant, but I don’t want this six-figure sum dragging on my portfolio’s returns, since I’m not sitting in cash for reasons of investment judgement. Rather it’s for time horizon and real-life reasons.

I also keep my NS&I index-linked certificates to one-side. Usually these are lumped into my house deposit in my thinking, but sometimes I judge they’re too precious for that. Anyway, they’re also off-spreadsheet.

Illiquid/unlisted equities lurk outside, too. More on those another day.

And then there are things that are really risky, silly, or unjustifiable – or all of the above.

Things like my (mini) mini-bond portfolio.

Mini guide to mini-bonds

I don’t have a vast amount of money in mini-bonds. All told around 1% of my net worth.

That’s my main defence out of the way! (One can easily argue that it’s still 1% too much.)

But what, you might ask, are mini-bonds?

The cynical answer is that they are the junkiest of junk bonds – pseudo-corporate bonds issued by companies so risky that professional investors wouldn’t touch them with a barge pole taped to a barge pole.

But I am not (quite) so cynical.

A mini-bond – like any corporate bond – is effectively an I.O.U. from a company in return for your money. An I.O.U. with legal obligations wrapped around it.

What it boils down to is you give your money to the company in exchange for the promise that your money will be returned to you at some point, with regular interest payments until then.

So far, so much like a corporate bond.

However there some differences:

Mini-bonds are aimed at retail investors (i.e. Joe Schmoes like us).

They are not traded on exchanges, and so they cannot usually be bought or sold. Rather they are illiquid. You invest in them when they’re issued, and you hold them to maturity.

The fixed lifespan of a mini-bond is short, with terms typically three to five years.

You are not covered by the Financial Services Compensation Scheme.

Some issuers have claimed they will allow existing mini-bond investors to rollover their bonds at the end of the term, which could be attractive depending on the environment (and the company’s fortunes).

Yields are far higher than what retail investors are accustomed to getting from conventional investment products these days, especially from savings accounts. However the risks are different, and much higher.

Mini-bonds are invariably issued by smaller companies – often barely start-ups.

You usually get perks for being a bondholder, dependent on the issuing company – discount cards, free coffees or cakes, that sort of thing.

The prospectuses are thinner than typical corporate bonds, and presumably legally less potent. (I suspect most people read neither anyway, and as a small investor, realistically speaking you’re relying on others in either case.)

So far so dubious, but these characteristics interact to make mini-bonds even dodgier investments than you might think, for an easily overlooked reason.

Your word is my bond

What mini-bonds most remind me of are investments from the old days – and by the old days, I mean the 16th and 17th Century.

Old, old!

Back then merchants and the occasional outré aristocrat would band together to put money into ventures untroubled by anything so futuristic as regulators, compensation schemes, or a transparent market.

This meant the soundness of an investment had to be entirely decided upon by the individuals.

Now you might think that still happens when a stock picker like me decides to buy, say, shares in Apple or IBM.

But that’s not really the case.

When I invest in publically listed shares, I am freeloading on the thinking of thousands of investors who’ve previously weighed up the pros and cons of the company concerned.

All their deliberations are (theoretically) in the price.

And when a passive investor buys the market via an index fund, they’re benefiting from this “wisdom of the crowd” writ large.

But mini-bonds (unlike conventional bonds) are not traded on markets. Because professional investors are not their target market, even the initial yield can be set without having to worry about pleasing the world’s smartest bond investors.

Indeed, to bother with the fuss of issuing a mini-bond, a company may have already been turned down for a low-hassle loan from a bank or a specialist investor – entities that know rather more than most of us about evaluating debt-hungry smaller companies.

No, mini-bonds only have to appeal to the hoi polloi like me.

In fact it’s even worse, because false modesty aside I’m surely at the more sophisticated end of the potential mini-bond buyer spectrum.

Indeed I sometimes suspect pricing might just come down to figuring out what’s the lowest yield the company can get away with to attract retail punters – with a few free donuts thrown in.

Reader, I bought some

It was this unattractive proposition that kept me away from mini-bonds when they first showed up. I even wrote a couple of strident posts warning of the downsides.

But over time, I’ve softened my stance a little.

I noticed early issues from brand-driven consumer-facing companies seemed to do well. In contrast, a couple of the more opaque financing-focused ones defaulted.

There was something to learn here, so I decided to invest some money.

I didn’t do so completely witlessly. I spread my modest mini-bond allocation among multiple issues to reduce company-specific risk. I read the prospectus and the business plans. I avoided mini-bonds that smacked of financial engineering.

In particular I concentrated on companies where I could see several reasons to raise money via mini-bonds, rather than going to a bank.

For example, consumer-facing companies might see the bond as a publicity boost, or a way to recruit thousands of advocates who will act as unpaid marketers in directing their friends and family towards their products.

Finally, all the bonds I’ve bought were via crowd-funding platforms. While this is no substitute for a true market, my feeling is there is potentially a wisdom of crowds effect here, or at the least a lot of people who can give a potential mini-bond a sniff test.

And I have seen several mini-bonds rejected and withdrawn.

That suggests you can’t just flog any old nonsense as a mini-bond. (At least it has to be a certain kind of nonsense!)

My mini-bond portfolio

I am not going to name specific mini-bonds. Rather, here’s my portfolio in abstract terms, which I built up over a couple of years:

Company / sector	Yield
Fast casual dining	8%
Coffee chain	8%
Property firm	7.5%
Speciality coffee chain	8%
Craft brewer	6.5%
Fast casual dining	8%
Coffee chain (2x position)	11%
Speciality food retailer	8%
Energy infrastructure	8%
Property firm (5x position)	10%
Average	8.9%

Source: My off-spreadsheet records

So, fairly diversified in terms of company specific risk, but not so much in the bigger picture, as it’s clearly a bet on the consumer economy, principally in London. (You probably won’t be surprised to hear I was happier with this before Brexit!)

More positively, you can see the yield is quite attractive – though probably not enough to really compensate for equity-level risk for fixed income returns.

What do I mean by that?

Simply it’s very possible that one or more of these bonds could default and see me losing some or all of my investment, without the compensation that others could go on to deliver years of “multi-bagging” returns like with shares. My upside is capped (the interest payment, plus my return of capital) and the downside could be 100%.

I’ve not had any bonds default yet – and I’m past the halfway mark for my oldest mini-bond. But I’m prepared for one or perhaps two to cause problems. Beyond that and this ‘fun’ mini-bond portfolio will become an expensive headache.

Regardless, my 1% net worth exposure is not going to change my world. Putting money into a mini-bond is not like buying the lottery ticket of shares in a small cap stock that could become the next Microsoft.

The most I can do is grow my 1% to 1.5% or so over 3-4 years.

Big whoop!

So why, really, did I bother?

Well one reason is that I don’t call myself The Investor for nothing.

I am interested in investments of all kinds, and I have a very high risk tolerance.

Shares, corporate bonds, unlisted companies, spreadbets, venture capital trusts, EIS schemes, National Savings certificates, fixed interest savings bonds, overseas stocks, options, investment trusts, funds, trackers, subscription shares, warrants – I’ve owned them all.

It also doesn’t hurt that I have a website that’s dedicated to this stuff.

I can chalk it up as homework!

Of human bond-age

More seriously, investing in mini-bonds (and in the equity of start-ups) is active investing without a safety harness. You’re pretty much on your own, as I explained above.

There are some upsides. Specifically, you often get to meet the entrepreneurs behind the companies in an informal environment in a way that it’s just not possible with the CEO of BP, say – or even a legally-hamstrung AIM company director.

You can see how they hold their drink when you ask them a tough question and then you can suck on your straw and observe their answer.

I’ve mentioned before that one possible future I see for myself is as some kind of active angel investor, or possibly even the owner of an investment-related company. Long before then, I want to repeatedly test my ability to evaluate whether people, companies, and my money should get acquainted.

I want to improve. Until I get a ticket at the big table, these crowd-funded offerings are one testing ground.

Possibly I’ll lose some money. There’s always a price to an education.

Mini mogul

I must admit I enjoy my mini-bond investments at least as much as my far more sizeable investments in listed shares.

It’s fun using your investor card, for example, at a start-up you’ve put money into, and to have a chat with staff about how things are going.

Heck, it’s nice knowing your money went directly into funding the growth of something new – rather than that you just bought some second-hand shares off another private investor like yourself.

True, it’s not nice enough for me to allocate more than 1% or so of my funds to mini-bonds. But I’m glad to be involved.

Incidentally, I’m especially glad given that the mini-bond opportunities seem to have dried up recently.

From talking to insiders, it seems part of the reason is that peer-to-peer platforms have undercut the yields on mini-bonds. So companies are going to peer-to-peer instead of bothering with the rigmarole of issuing a mini-bond.

Will this end in tears? Will my mini-bond portfolio crash and dwindle, for that matter?

For all the talk of reinventing finance, it’s hard not to believe that the various Fintech¹ innovations are being at least partly nurtured by super low interest rates that have encouraged bolder investors to venture into exotic and newfangled products.

And it seems unlikely these will all prove to be a ‘free lunch’ in the wider tale of investors chasing yields.

Time will tell. At least I got a free coffee…

Financial Technology.

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