What are mini-bonds - and after the Providence Financial collapse, are they safe?

Savers on the hunt for income have received a timely lesson in risk this month after two so-called "mini-bonds" launched by Providence Financial have collapsed, potentially losing investors collectively more than £8m.

What has happened?

In 2014 Providence Financial Investments launched a mini-bond offering quarterly interest of 8.25 per cent. It then launched another one last year promising 7.5 per cent interest.

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Those are high rates of interest and proved extremely attractive to some in an age of ultra-low returns on cash and standard bonds.

It is believed that 825 people have invested in the bonds with a total of £8.15m invested – that’s nearly £10,000 each.

After a late interest payment the company has now gone into administration and it is highly unlikely investors will see their money again.

The company was marketed as "as an investment is a 'fast-growing, global commercial and financial services group' that had offices across the world. Savers enjoyed multiple levels of security, according to the promoter, London-based Independent Portfolio Managers," says Patrick Collinson in The Guardian.

But, the firm has now been ordered to stop trading by the Securities and Exchange Commission in the US, following an investigation that it offered ‘ongoing fraudulent and unregistered’ securities.

What are mini bonds?

This is a system similar to retail bonds, where you lend money to a company and in return you get a fixed rate of return for a number of years. After a set period of time the bond matures and your capital is returned to you.

But, that is where a mini-bonds similarity to a retail bond ends.

Mini-bonds are issued by far smaller companies than retail bonds generally - and because you are taking on the risk of lending to a small business the interest offered is usually sizeable. Seven to ten per cent isn’t unusual.

Unlike retail bonds mini-bonds cannot be traded on the stock market. That means you are stuck with it until maturity. Also, mini-bonds aren’t subject to the same intense scrutiny as retail bonds, meaning you have to do the legwork yourself to see how risky they are.

You need to look at the companies accounts and reports, find out what the bond debt is secured against, discover where you stand in the pecking order if the firm goes bust.

And remember "investors should bear in mind that it can be harder to judge the risk involved in investing in some bonds than in others – it is easier to assess the likelihood of Tesco going bust than smaller more specialist businesses," says Lee Boyce on Thisismoney.co.uk.

Are they safe?

"The collapse of Providence Bonds earlier this month is not the first time a mini-bond has gone south and is unlikely to be the last," says James Connington in The Telegraph.

"The often-controversial investments can promise big returns... While investors are told to steer clear when something looks 'too good to be true', such offers can prove tempting when interest rates are near zero."

The first problem with mini-bonds is that they are not covered by the Financial Services Compensation Scheme. This means if the company issuing the bond goes bust the only chance you have of seeing your money again is if the administrators manage to pay you something.

That's a highly unlikely scenario given how low down the creditor pecking order these bonds sit.

The second issue is that mini-bonds aren’t particularly stringently regulated. "The rules concerning mini-bonds are less onerous. For instance there is no requirement to produce financial statements," says Connington.

"If you are a cautious investor, or could not cope with losing any money, mini-bonds are not for you," says Ali Hussain in The Times. "They may offer a higher rate of interest, but without protection, your money could disappear."

That's exactly what Provident Financial Investments bond-holders are now discovering.