Fresh warning over high-risk mini-bond investments – what to watch out for

Investors are being encouraged to put their money into high-risk schemes offered by unregulated firms without appreciating the dangers involved, according to a warning from watchdog the Financial Conduct Authority (FCA).

Some of the particularly risky products the regulator has seen investors being targeted by have been unlisted loan notes, also known as mini-bonds. Unlike regular bonds which tend to be lower risk investments, investors have a high chance of losing all their money in mini-bonds, whether they are only just learning how to invest or even more experienced.

Unlisted loan notes, or mini-bonds, previously emerged on the investing scene in 2018 but are making an unwelcome comeback. They come in several forms and are often used to finance property developments. This involves an investor lending money to a company, often via a third-party firm, to fund building projects.

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Mini-bonds often come with promises of high ‘guaranteed’ returns of as much as 8%. With billions of pounds of savers’ cash languishing in savings accounts paying 1% or less – Paragon Bank’s analysis showed there was £10.6 billion in savings earning 1% or below in June, rising from £4.6 billion at the end of January – such promises are increasingly enticing.

But while all investments come with risk, for products like mini-bonds the dangers of losing all your money can be particularly acute. “They are generally for experienced investors who feel confident in assessing the quality of the company’s business and the likelihood of being repaid”, the FCA said.

Risks of using unregulated firms

Many of the firms offering these risky products rely on exemptions in the law that take them out of the FCA’s remit, meaning they don’t need to be authorised by the regulator to do business.

But if a firm offering an investment is not regulated by the FCA, investors dealing with that firm are generally afforded far fewer protections and ways to complain.

For example, you are unlikely to be able to take complaints to the Financial Ombudsman Service and you’re unlikely to be able to make a claim through the Financial Services Compensation Scheme. That may make it much harder to get your money back if something goes wrong.

‘Guaranteed’ returns

The opportunities the FCA has seen being offered typically come with a fixed, high rate of return, which is a promised annual rate of interest paid to investors.

However, behind the glossy promotional and eye-catching brochures can sit high risk, opaque or even non-existent enterprises.

In judging whether a promised fixed return is relatively high, which often indicates a high investment risk, it can be helpful to compare it with what is on offer on other fixed return products.

For example, the current best one year fixed rate savings account is from Chetwood Bank, according to data from Savers Friend, and is paying 4.28%. Supposedly ‘guaranteed’ returns far above that level should be treated with caution.

People selling high risk, unregulated investments typically draw people in with enticing websites, marketing campaigns and social media finfluencer promotions. If someone introduces you to the investment, they may take a fee for doing so. This would generally be taken from the amount you've invested.

If you’re considering investing, use the FCA register to see whether a firm is regulated and if the level of risk is right for you. Some investments, including unlisted loan note or mini-bond investments, are not considered by the FCA as suitable for everyday investors.

Investments for sophisticated investors

Many companies and individuals that promote these high-risk investments don’t need to be regulated, and exemptions in the law mean certain high-risk investments can be marketed directly to wealthy or experienced investors, known as a ‘sophisticated investor’, under strict criteria.

In the UK, potential investors can self-certify that they are sophisticated. But this shouldn’t be a decision taken lightly.

“If you’re asked to confirm that you are a sophisticated investor, think carefully about whether you genuinely have experience of similar high-risk investments, and whether it’s in your best interest,” the FCA said.

“Otherwise, you could be exposed to investment opportunities that aren’t appropriate and certain regulatory protections will not apply.”

A good rule of thumb is to limit any exposure to high-risk investments to only 10% of your portfolio.