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The US regulator, the Securities and Exchange Commission (SEC) has begun an investigation into Miami-based Providence Financial Investments, which has been accused of offering fraudulent and unregistered securities. The firm has been told to stop trading.

The investigation highlights the risks investors take by investing in so-called ‘mini-bonds’, particularly if they are offshore or form part of the assets of offshore funds or companies.

In the case of Providence, investors were buying bonds that in turn underwrote factoring activities in Brazil, namely buying unpaid invoices at a discount in order to pursue debtors and have the invoices paid in full.

Here’s Why Should You Tread Carefully

Mini bonds are frequently not subject to investor compensation schemes – they are not onshore, regulated products, even if they are being sold by regulated brokers and wealth managers. They are, however, popular, as they offer investors higher yields than cash, savings accounts, or many other fixed income investments.

The SEC said that close to 40% of the money invested with Providence Financial had not been invested in Brazilian factoring deals, and the company was having a hard time accounting for the difference.

In 2015, another mini-bond, marketed by FCA-regulated International Portfolio Managers, went into administration, losing investors over £7 million in the UK. Again, it has proved impossible to secure recompense through investor compensation schemes.

Many businesses are turning to private investors as a source of finance at the moment, and the mini bond is proving a popular instrument to do so. Such bonds are sold by wealth managers, financial advisors, and on third party platforms. Because they bring with them higher risks than gilts or treasuries, they typically pay higher rates of interest. Typical durations for mini-bonds are between three and five years.

A good example is the £3.5 million bond issue by Oval cricket ground in south London, which paid investors 5.5%.

Investors are encouraged to approach mini-bonds with caution, as they are potentially high risk investments. In particular, offerings of offshore bonds – e.g. from the Channel Islands – should be scrutinised with great care.

The Armchair Trader Says….

Steps are being taken to bring higher standards into this part of the investment industry – e.g. through the establishment of the Peer to Peer Finance Association. There are many fears – expressed privately by some financial professionals to The Armchair Trader – that the mini bond market or indeed the entire peer to peer lending craze, could be the source of the next financial conflagration.

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Stuart Fieldhouse

Stuart Fieldhouse

Stuart Fieldhouse has spent 25 years in journalism and marketing, including as a wealth management editor for the Financial Times group, covering capital markets and international private banking, and as an investment banking correspondent for Euromoney in Hong Kong. He was the founder editor of The Hedge Fund Journal.

Stuart has worked at CMC Markets, supporting the re-launch of its global financial spread betting and CFD trading platforms. He is also the author of two books on trading, published by Financial Times Pearson. Based in The Armchair Trader’s London office, Stuart continues to advise fund managers, private banks, family offices and other financial institutions.

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