No matter what kind of investor you are, due-diligence is crucial

One harsh reality of the recent collapse of mini-bond issuer London Capital & Finance is that not everyone at the top of a company or offering financial products always has their investors’ best interests at heart


Ben Arnold

Ben Arnold

Investment Specialist, Equity Value

As value investors, we may do everything we can to keep emotion out of our decision-making process but that does not mean, here on The Value Perspective, we do not feel a great deal of sympathy for the thousands of savers now facing heavy losses after London Capital & Finance (LCF), an issuer of so-called ‘mini-bonds’, went bust earlier this month. 

The last week or two have seen some very sad stories emerging in the press of people who now fear they have lost all their savings.

Almost 12,000 people are thought to have directed a total of around £236m towards LCF mini-bonds and the company’s administrators have been quoted as saying they may see as little as 20p back for every £1 they put in.

Marketing promotions – many of them targeted through social media – promised fixed interest rates of up to 8% if people saved for three years.

They also said returns would be free of tax if the mini-bonds were held in an ISA – although a major concern of the Financial Conduct Authority (FCA), the UK’s financial services watchdog, when it began an investigation into LCF’s promotions was these products were not ISA-eligible.

Returns too good to be true? 

Clearly the prospect of an 8% tax-free yield – in “fully secured ISAs” as some of what social media platforms call ‘suggested posts’ but most people would recognise as ‘advertisements’ put it – was hugely attractive to many people.

Yet, at a time when Bank of England interest rates were at or near historic lows and very few other ISA deals edged above 2%, hopefully it is not too unfair to suggest alarm bells should have rung.

The cliché, of course – and it is a cliché for a reason – is that if something looks too good to be true, it probably is.

Indeed, some LCF savers interviewed in the press said this was precisely their first reaction but that they had gone on to invest after receiving various “reassurances” from the company – though that does raise two further considerations.

Due diligence is key

One is the importance of doing appropriate due-diligence with any kind of investment or financial product – in other words, regardless of whether you are a private individual, a financial adviser or a professional investor, you carry out your research and you ask a lot of a questions before you part with your or your clients’ money.

Key questions in the case of LCF might have included how it planned to pay such a high rate of return when few banks or other financial businesses felt able to pay more than a percent or two; just how much risk the firm was taking on offering loans to small businesses in order to pay that rate; and the implications for savers’ money given there was no Financial Services Compensation Scheme protection should LCF go under.

What are their interests? 

The other – interlinked – consideration is the harsh reality not everyone at the top of a company or offering financial products always has their investors’ best interests at heart. In their letter to the mini-bondholders, for example, LCF’s administrators highlight our earlier point about the products being promoted as ISA-eligible despite the FCA deeming otherwise.

The letter also notes “concerning connections” between people currently or previously involved with LCF and people currently or previously involved with business to which loans were made, and that the fact some £236m of bondholder money was lent by LCF to a small number of borrowers “shows a lack of the spread of risk that one would expect from a professional portfolio manager”.

“The bondholders believed that their money was being lent to a wide portfolio of UK small and medium-sized enterprises,” the letter continues, “but they now find that it has been lent to a small number of complex businesses with substantial risk profiles and which are often dependent on foreign and/or exotic (such as oil and gas) assets.”

Underlining the point some businesses do not put their investors’ interests first, the administrators detail how LCF had agreed to pay an agent 22.5% to 25% of the total amount raised by the mini-bonds.

The £60m or so subsequently paid to the agent, in combination with other fees, meant the mini-bonds would need to generate returns of up to 44% a year for bondholders to be repaid in full.

There is a degree of understatement in the administrators’ conclusion: “It is clear the process of working out the borrowers’ loans in order to generate sufficient funds to repay the bondholders is going to be complex.”


Ben Arnold

Ben Arnold

Investment Specialist, Equity Value

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