(What I learned about selling retail bonds from a FCA registered Company operating in the Peer 2 Peer sector)
Bonds have long been a favourite of the City. Ever since the 90’s and the days of “Bonfire of the Vanities” Government’s love them as they are nothing more than an eternal IOU that fill the gap what Taxes cannot reach.
Investment Banks buy and sell them in the OTC market particularly through inter dealer brokers and traders buy and sell them on the International Exchanges. In these instances the Bonds are tradable and their price is key in terms of the yield. For this reason they are particularly responsive to interest rates and inflation.
The multi nationals also sell their bonds on the financial markets and these Bonds are generally tradable. Their coupons are higher than government bonds as they are deemed to be somewhat riskier. Even so the size of the multi nationals and the probability of default can place them higher in terms of their credit ratings than some sovereign countries.
Ratings by the Main Rating Agencies are key here. The Moody’s, Fitch or Standard and Poor are credit ratings that grade the quality of the Bond.
In terms of Risk v Reward ratios the rule of thumb here is:
The lower the risk the lower the Coupon paid out.
The higher the Risk the Higher the Coupon paid out.
The Shorter the duration (term) the lower the Coupon paid out
The longer the duration (term) the higher the Coupon paid out
But Bonds are very complex instruments:
Dividends not Bonds:
When we think of dividends these can seem like a fixed income instrument but the payout is generally variable and your capital will fluctuate. Bonds are used primarily for their predictable income and diversification away from the stock market.
Private Companies selling Retail Bonds
Many companies in an effort to get funding have chosen debt over equity. Why? Because debt means they retain control over their company. It means that all the money is going to them, there are less charges and also less regulation. They keep all the upside and minimise the downside, especially if it’s an unsecured bond.
The new Pension Liberation has given access to the tail end of the “Baby Boomers” generation. These are the generation that “Never Had It So GOOD!” as Harold Macmillan once famously said.
This is the generation that has benefited from the following:
Near full employment for the older members
Proper wage raises
Generous final salary pensions
Meteoric growth in their Property prices
Free University education
Strong stock market appreciation over the last 40 years.
The providers of these Bonds target this generation because they actively seek income over growth. As, they are living in an Era of low interest rates and high inflation. They are in a fundamental squeeze and their hunt for yield is pushing them towards more riskier asset classes. On top of this access to an Independent Adviser is becoming more the realm of the wealthy, at a time when a recent survey finding discovered that 98% of people who left school felt that they had been inadequately prepared in personal financial matters.
However, they need to appreciate that private company bonds or Junk Bonds are very very risky. To alleviate these fears many of these companies state their bonds are asset backed, often to property or stock. But to be realistic when a company goes down the pan, often their assets value plummet considerably. Everyone knows that the moment you drive a new car off the forecourt it’s instantaneously lost 25% of it’s value. It’s called depreciation. That’s great for buyers not for sellers.
I worked with a company active in the Peer2Peer sector, the Peer 2 Peer sector is a nascent sector that has seen exponential growth. This is because they are entering into the space where banks used to not only occupy but also be a cartel. Initially I was pleased to be working in the City once again and as a professional my sales were strong. Then I started to question whom I was working for and what exactly was the underlying. Why were they targeting Pensioners with an Advertising Campaign "Pensioner Bonds are back!". Once that happened my sales plummeted. I am proud to say that I was shown the door for ".... your lack of enthusiasm.. ". Unfortunately, the first sale a company makes is to the Sales Man selling its services. In the end I found myself posting this old Ska tune to a colleague.
The Company issuing the retail bond in the peer2peer sector often used to explain to potential bondholders, many points that I wholly disagreed with and was thoroughly suspicious about. For a client to carryout due diligence a company will bend over backwards to address the questions raised, in the army we used to call it "BullSh*t Baffles Brains" . If you are working with them, to do the same you are shown the door. Having my own doubts and listening to clients carried out some of my own research. The due diligence uncovered a lot that is in the public domain. A Mr. Dror Israel Sordo was one of the Directors . Mr Dror Israel Sordo has also been a director of Plus500 and more significantly a company formally called Win Global Markets Inc. (Israel) Ltd but renamed EZTD Inc, where he was employed as the Chief Financial Officer. EZTD Inc was investigated by the Securities and Exchange Commission ( the U.K equivalent of the FCA) for misleading investors, over 4,000 to the tune of $1,500,000. The Israel Times give an interesting over view of EZTD Inc :
"Israeli binary options firm to repay money it fleeced from 4,000 American victims."
All this happened back in November 2016 one month just before the Company was incorporated.
The main concerns that sparked my suspicions were as follows:
1.The Marketing executed was targeting Pensioners up to the age of 96 who have been looking for the National Savings and Investment (NS&I) website. In particular Pensioner Bonds. Having typed this into the search engine or called into the office they were through to a completely different entity. Although this was explained to them, many were frustrated and felt deceived.
2.They were told that the loan book, that the bonds derived their revenue from, was asset backed. It may well of been, but the actual bond that the Bondholder purchased was not.
3. Many of the “Dedicated Relationship Managers” aka call center sales representatives with no financial qualifications or experience confused the term investing with lending. So, gave the impression that the company was investing in multiple businesses when they actually meant they lent to these businesses.
4. They often said the money was lent to FCA registered companies,what was not mentioned was the FCA registered company was nothing other than a Payday Loan Company, would you invest your Pension in a Pay Day Loan Company?
5. It was often stated that Corporate debentures were some of the assets used as collateral, indeed when the fallacy of this idea was pointed out, the management asked me to refrain from stating the obvious. However Credit Default Swaps were sometimes a mixture of debentures, and they caused the financial melt down back in 2008.
6. Clients were told that the Company co-invested their funds along side their client’s funds to businesses on the same loan book. This is highly improbable, as the highest yield was 7.72% even when one factors in a higher rate of say 15% it’s highly unlikely a start up business would be satisfied with a return as low as this given the risk of developing a business.
7.The Management on the books had a high turnover considering the short time of it's existence, in the end there was only one director. However, he appeared to be a front man. The "Mr Bigs" resided in Israel some came from a pay day loan call center background. The Director on the books had no professional financial qualifications at all. As the company had only been trading for under a year, it’s accounts showed nothing. Nevertheless its turnover was in the Millions per month.
8.While situated in the City of London, the managing director seemed little more than a front man. The real decisions were made in Israel where the main backer who had invested GBP 2,000,000 into the Plc version of the company resided. It appeared that the Israeli connection had close ties with the Binary Options sector in that country, his name was mentioned in the Israeli times in connection with a binary options company that was investigated by the SEC.
9. Sales, were generated via the Internet and physical brochures were actively discouraged preferring that they applied online.
10.The big issue with the Peer 2 Peer Company was “Looking under the Bonnet” no evidence was given regarding where the money was lent out to.The directors themselves cited not wishing to let institutional investors know:
“How the magician, pulls the rabbit out of his Hat.”
11. It things go wrong or the money were to disappear, how would the liquidators locate the money given that principle management decisions where coming from Israel. There were no risk department to speak of so who was monitoring the quality of the so called loan book?
12. To it’s credit it the company is an appointed representative and on the Financial Conduct Authorities register. And if you were missold you were protected up to GBP 50,000 for any misselling!
13. The Company has been featured in the Daily Telegraph and most recently the Daily Mail. "Are Pensioner Bonds really back?"
However the biggest pause for thought in my opinion is this. As a trader one trades not only in probabilities but also risk and rewards.
Risk Reward Ratio
Trading v a Junk Bond
As a trader I am not going to take the trade unless I have a strong probability of making between $3-4 for every $1 I place at risk. It’s called the risk reward ratio. With a Junk bond you risk $1.00 to gain 0.10 cents! That’s far too much down side risk for me. Why?
1.The upside is severely limited
2.The Bond is not transferable
4.They are not rated by a ratings agency
5.The return doesn’t cover the risk
So what if you already hold one of these Bonds!
In my opinion:
If a significant amount of your wealth is tied up in such a bond.
Think about selling!
Redeem the bond early before “the sellers rush” once the company is plagued by a bevy of “Black Swans”.
Take the hit on the Charges. As we used to say on the trading floor:
“The first Stop is the Cheapest”
Ring fence your capital, if you really need fixed income then own quality tradable bonds. Or go back to strong dividends from those lovely Blue Chips. If its income you need you can always take the dividend payments and pass on the principle as a legacy to a relative with a longer future horizon.
This video clip of the old film Ronin sums up my thoughts exactly: