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Be cautious when seeking income

Mini-bonds are going out of fashion, says David C Stevenson. But they do still have some redeeming features.

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Would you take 8% for lending to a pie shop?

A couple of weeks ago, restaurant chain Square Pie folded. There's nothing particularly interesting about a food chain going down, of course. But Square Pie had sold bonds on the Crowdcube platform, offering lenders 8% a year. It illustrates why so many people are suspicious of mini-bonds (debt issued by small, retail-orientated firms). Anyone thinking of lending to just the one relatively new business has to be aware of the risks and then ask: is 8% enough?

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This type of mini-bond is much less common than it used to be, as the wider trend has been to make bonds or lending to small businesses in general more diversified. Yet the aim is still to provide income-starved investors with a decent yield, just backed by a wider range of projects.

A more diversified option

The latest offering in this category comes from a platform called Goji, which aggregates a variety of direct-lending and peer-to-peer (P2P) platforms. It has just brought out a Renewables Lending Bond, which pays out anything from 5.5% for a three-year term (with regular income) to 7.6% over five years, where the interest is rolled up at repayment. The underlying assets are provided by a direct lender called Prestige Group, which lends to clean-energy projects. Goji has gone out of its way to reassure investors, appointing independent directors, custodians, administrators and compliance experts, as well as an independent security trustee.

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The book of loans around 39 has an average duration of four years, with a typical loan-to-value ratio of between 70% and 80%. Crucially, this book of loans should be backed up by a reliable stream of income from renewables subsidies. The bond looks and feels very similar to the smart-meter bond currently being marketed by Foresight, which lends against assets as well smart meters and yields between 4% (for the one-year version) and 4.83% for the three-year bond, with interest rolled up.

The idea here is diversification for income investors with the moral of the story being not to lend to just one project. In that sense, the more direct comparison is with either listed investment trusts such as P2PGI and VPC (which haven't been an astounding success) or more specialist online platforms such as BondMason and WiseAlpha. These last two alternative-finance platforms lend their investors' money out across a range of borrowers, in order to build a diversified income.

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In BondMason's case, the platform selects its loans from a wide range of P2P and direct-lending outfits, and is currently churning out an income yield of well over 8% a year. WiseAlpha takes a slightly different approach, and invests in senior secured corporate debt and loans from well known names such as the AA, Aston Martin and Virgin. Its Smart Interest product invests in a pool of these loans and bonds, and churns out an income of between 3% for a one-year term through to 6% over five years.

The risk-free rate is rising

The key with all of this is to think about how long you want to lock away your cash. Tying up your money for a year is much less risky than signing up for a five-year term. Why? The "risk-free" rate is currently on the increase: US ten-year Treasuries are already yielding not far off 3% a year, and could get to 3.5% this year. These increased rates will wash back into bond markets and we should expect to see reasonably low-risk government- and investment-grade corporate bonds yield anything between 2% and 4%.

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Given this, any bond or income-based asset investing in risky private assets needs to be paying at least 3%, if not 4% to 5% with five-year durations yielding above 6%. And even at those rates I'd be cautious. There has to be a decent chance that the current global business cycle could turn down within the next two years. In the inevitable economic slowdown we should reasonably expect all private business assets including those with a renewable subsidy to experience increased default rates.

News bytes Zopa warns of rising P2P default rates

Peer-to-peer (P2P) lender Zopa is expecting a higher rate of default on its loans than during the financial crisis, says Kate Beioley in the Financial Times. Zopa originally expected 4.14% of loans originating in 2016 to default, but recently revised this up to 4.93%. Loans from 2017 are expected to default at a rate of 4.86%, up from 4.52%. For loans from 2008, Zopa expected a default rate of 3.58%, but actually saw a rate of 4.2%.

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The higher defaults are a result of higher-risk lending, says Zopa in 2016, it began lending to higher-risk borrowers in an attempt to boost returns. But estimated annual returns are now falling, too. The return on 2017 loans stands at 4.7%, below the 4.9% of loans from 2016, and the 5.2% of loans from 2011 and 2012. This is as a result of adding lower-risk, lower-return loans at the same time as the higher risk loans, according to the platform.

Stelios Haji-Ioannou, the founder of easyJet, has relaunched his financial services brand, easyMoney, and is offering an innovative finance individual savings account (IF Isa) that he says will return 4.05%. The IF Isa will invest in "multiple property-backed P2P loans", with all loans being "secured by a first legal charge over a property". It is aimed at investors who have "had enough of the poor interest rates offered by cash Isas and are nervous about the potential volatility of most stocks and shares Isas". The IF Isa is not backed by the Financial Services Compensation Scheme (FSCS).

Revolut, the smartphone app that allows users to transfer between currencies at no cost, has broken even for the first time, says James Titcomb in The Daily Telegraph. The firm launched its service in 2015 and now has 1.5 million accounts numbers have increased by 50% in just two months and is valued at £300m. The app has 350,000 daily users, with between 6,000 and 8,000 new accounts opened every day. Earlier this year, Revolut added cryptocurrencies such as bitcoin and ethereum to the list of currencies available to buy and sell. Last year, it applied for a European banking licence, which will allow it to offer full bank accounts.

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