Smaller companies are increasingly raising loans directly from the public instead of banks – and last week we saw two especially colourful examples. Innis & Gunn, an Edinburgh-based brewer, wants to raise £3m-£6m to construct a new brewery, via a four-year mini-bond with an annual interest rate of 7.25% – or 9% if you’re willing to be paid in beer. And rugby club Wasps is refinancing the loan it used to buy its new stadium through a £35m seven-year retail bond paying 6.5%.
For firms, deals like these are a way to get loans at lower rates than banks charge. For fans or customers, they offer a way to back something that matters to them. But is there anything here for investors?
Back the Wasps
Let’s take the Wasps retail bond first. Retail bonds are corporate bonds intended for individual investors. Traditional corporate bonds usually trade over-the-counter (meaning deals are arranged between brokers) and in large minimum deal sizes – often £50,000 or £100,000.
By contrast, retail bonds are listed on the London Stock Exchange (LSE) and are traded in small blocks: most can be dealt in sizes as small as £100 after they float. It’s important to be aware that investing in a bond is not like putting your cash in a savings account: if the company is unable to pay you back, you are not covered by the Financial Services Compensation Scheme, so you could lose your money. Since retail bonds are traded on the LSE, you should be able to sell before the bond matures if you need to, but the price may be less than you paid.
Retail bonds are a great idea, in principle. They allow investors to build their own bond portfolios, instead of having to invest in corporate bond funds. But the retail bond market is still small (around 100 bonds at present) and demand from investors is fierce. So yields on retail bonds tend to be too low compared to similar corporate bonds owned by institutions – and that looks like the case with the Wasps bond.
The headline 6.5% yield may seems moderately attractive at first, given that it’s secured against the stadium. But Wasps looks risky (it’s making losses at the operating level). And while the stadium’s been valued at £48.5m, it’s hard to be sure of the true resale value of an asset like this if the club went bust. Other investors may disagree, but in my view the return doesn’t compensate for the risk.
Help build a brewery
If retail bonds are typically overvalued, what about mini-bonds such as the Innis & Gunn one? These are a far riskier proposition, since they aren’t listed on an exchange and generally can’t be sold, transferred or redeemed early. So once you’ve invested, your money is locked away until they mature. That by itself means that companies should pay a very large premium to reflect this lack of liquidity. A further problem is getting enough information about the company issuing them to form a view on how risky they are, since mini-bond issuers are typically private, early-stage companies.
The Innis & Gunn mini-bond struggles on both these scores. The 7.25% coupon isn’t anywhere near enough to compensate for the lack of liquidity, in my opinion, while the information in the offer document isn’t sufficient to form a view on the firm’s prospects. For somebody who likes these beers and wants to help the firm to expand with some spare cash, the offer might be OK – but as an investment, this kind of deal makes no sense at all.
The jargon explained
Investing in bonds is simpler than investing in shares because there’s less uncertainty: you know from the outset what the bond should give you if all goes to plan. However, it still requires learning some new principles. Here are a few basics.
First, the jargon. The interest payment you receive from a bond is known as the coupon. These will typically be paid every six months, even though the interest rate will be quoted as an annual figure. When the bond matures (on the maturity date), you get back your initial investment, which is known as the principal, face value or par value.
While the coupon tells you how much interest you’ll get, it doesn’t represent your overall return on the bond. That’s because when you buy a bond in the market, you may pay more or less for it than the value of the principal you’ll get back at maturity – meaning that you may make a capital loss or gain. So it’s important to consider the yield to maturity, which measures your total return if you hold the bond until it matures.
If the company defaults (doesn’t pay the interest or principal), your return will be worse. So you need to consider how strong the borrower’s finances are. Unlike investors in shares, who care about after-tax earnings, debt investors often focus on earnings before interest tax depreciation and amortisation (Ebitda) as an imperfect way of measuring how much cash the firm can generate to keep paying its debts.
Key ratios to consider are leverage (the ratio of the company’s debt to its Ebitda – lower is better) and interest coverage (the ratio of Ebitda to interest payments – higher is better).
• For a short and readable introduction to investing in riskier bonds, one useful book is How to Make Money With Junk Bonds by Robert Levine (McGraw-Hill, £13.99).