Lending money to businesses at a fixed rate is an established way for investors to get a regular income and fixed-interest securities have always formed part of a balanced portfolio for Sipp investors.
But deciding which securities to choose has become much harder in recent months. As the turmoil in Greece has caused concern for investors in sovereign debt, corporate bonds have looked increasingly attractive. But ratings downgrades of cash-strapped com-panies and fears of rising inflation have made investment selection in the fixed-interest space much trickier.
The irony is that, just when some advisers are counselling clients to tread carefully with corporate bonds, particularly where purchased directly rather than through a fund, household-name companies are using the poor returns available on ordinary bank and building society accounts as a marketing platform to push their own bonds direct to the public.
Among the offerings this year have been bonds from high-street retailers Tesco and John Lewis, in the finance sector from Lloyds Banking Group and door-to-door lender Provident Financial and even housing associations.
For buyers wanting to make maximum use of tax perks, the Tesco, Provident and Lloyds bonds could all be purchased for inclusion in an Isa or a Sipp but the John Lewis bond could only be purchased for holding direct as the company is not listed.
AWD Chase de Vere head of communications Patrick Connolly says: “Investing in just a single company is a higher-risk approach, especially if the investment represents a reasonable proportion of a client’s overall savings. Therefore, individual corporate bonds, even from trusted brands such as John Lewis, are unsuitable for those with smaller portfolios who do not have the resources to invest in a diversified range of individual bonds.”
’Those lending money need much greater levels of knowledge as not only do they need to decide which companies to lend to but they must also make their own investment decisions regarding the interest rates they require’
Connolly is also concerned that investors may not be fully aware of default risk and the lack of access to compensation. He says: “We have seen in recent times how even supp osedly strong and secure companies, such as the high-street banks, can get into financial difficulties and investors in individual bonds cannot fall back on the Financial Services Compensation Scheme if the bond provider is unable to repay investors’ money.”
Does that mean that corporate debt is dead as a Sipp investment? On the contrary. More adventurous investors are also looking further afield than multinational companies or high-street names for Sipp investments with good returns. The latest investment avenue is peer-to-peer lending, which is seeing its image transformed from loans for sandal-wearing bank-haters to an efficient way for smaller businesses to raise the money they need for expansion.
Probably the most familiar name in the P2P lending sphere is Zopa, which launched in 2005 and allows private lenders and borrowers to transact directly with each other, circumventing the banks.
Similar schemes are starting to come on to the market for private lenders to advance funds to small businesses. The most prominent to date is Funding Circle, which launched last year, while the latest to come on stream is ThinCats, which promises lenders a regular fixed monthly repayment income at a rate of interest ranging between 7 per cent and 15 per cent, dependent on the risk level chosen by the investor.
ThinCats has extra appeal because its secured business loans are Sippable, making ’Those lending money need much greater levels of knowl-edge as not only do they need to decide which companies to lend to but they must also make their own investment decisions regarding the interest rates they require’
it suitable not just for indiv-iduals but also for pension fund trustees.
Tom Moore, an experienced investor who has made four loans via ThinCats, says: “ThinCats appealed to me because it provides direct access to low-risk investment opportunities which, up until now, have been the preserve of the banks.”
So, how does it work? Those wanting to lend, which can include Sipp trustees seeking a fixed-rate, fixed-term investment, take part in an online auction to join a lending syndicate for each loan. A prospectus describing the nature of the business needing the loan and the security provided is prepared by a ThinCats “sponsor”, an experienced banker or finance specialist. This should give investors the information they need to decide which loans to bid for.
At the end of the auction, the lowest bids needed to make up the loan are accepted into the syndicate and each lender receives the rate of interest he offered. The minimum share of a loan is £1,000 and the maximum is the whole loan, however big. ThinCats says that, so far, the most common bid has been £5,000, but bids of £50,000 are not uncommon. Once the auction has been completed, ThinCats arranges all the legal documents, holds the security on behalf of the syndicate and arranges collection of the repayments and allocation of the funds to each lender.
ThinCats managing director Kevin Caley says: “Up until now, peer-to-peer lending sites have facilitated smaller, unsecured loans but we have shown that there is a demand from serious investors and established businesses for a more sophisticated service, providing access to the secured lending market previously dominated by the banks.”
Private investors, including those managing their own Sipps, need to exercise caution, however. Connolly says: “Those lending money through operations such as ThinCats need much greater levels of knowledge as not only do they need to decide which companies to lend to but they must also make their own investment decisions regarding the interest rates they require.”
Investors particularly need to be fully aware of the risk of default. ThinCats says: “In the event that a business falls behind with its payments, the sponsor who drew up the prospectus is responsible for working with the borrower to overcome the problems in agreement with the loan syndicate. This might involve rescheduling the loan. As a last resort, ThinCats would call in the loan security. To date, there have been no missed payments or loan defaults.”
Connolly says: “This type of initiative should only be considered by sophisticated investors. Even then, there will only be a small percen-tage of investors where this may be appropriate.”