Do alternative savings offer happy returns?
Corporate bonds, structured products and peer-to-peer lending can beat cash savings, says Chiara Cavaglieri. But at what cost?
Sunday 20 April 2014
Squeezed savers are being tempted by investments that promise to beat the banks – and with cash rates so poor, the appeal is easy to understand. If you are looking to generate a higher return, however, be aware that the alternative investments carry surprising risks.
Investors like these because they offer less risk and a higher income than shares. When you buy a corporate bond, you are basically lending money to a company in exchange for a fixed level of interest each year, plus all of your capital back upon maturity. Retail corporate bonds – issued by big-name companies such as John Lewis, National Grid, Stobart, Provident Financial and even The Jockey Club – are particularly popular.
Patrick Connolly of the adviser Chase de Vere says: “For many investors, corporate bonds would seem like a logical [alternative] to cash savings. They pay a fixed rate of interest, which is higher than that available on savings accounts, and return your money at a predetermined time in the future.”
Yet the bonds are investments, not savings products. That means there’s no Financial Services Compensation Scheme (FSCS) protecting up to £85,000 of your money. A corporate bond is only as secure as the company behind it, and unless you’re an expert, calculating the return you get for the risk can be very tricky.
“Investing in a single company is a high-risk approach,” Mr Connolly adds. “We have seen how even supposedly strong and secure companies, such as the high-street banks, can get into financial difficulties.”
Corporate bond funds are one way to spread the risk because you invest in a number of different companies. But you will pay annual fees of around 2 per cent to a fund manager who could still make a few bad calls.
These are often pitched at cautious investors, but they are not as safe as they seem and can be very difficult to understand. The big sell is that you can beat returns on cash savings while still protecting your capital through a counterparty that guarantees the return of your initial stake.
Structured products are sold under many names – such as guaranteed equity and income bonds, growth deposit plans, guaranteed capital plans, protected investment funds. The problem with all of them is that there is no “guarantee” that counterparties won’t default. This is something that around 6,000 investors found out the hard way when Lehman collapsed in 2008.
When they work well, returns can be far superior to cash, but many structured products have limited scope to perform. You might actually get less interest than you would with an ordinary savings account, or even no interest at all, and you don’t benefit fully from any rise in the stock market – as you would with shares. Adrian Lowcock at the adviser Hargreaves Lansdown says: “A structured product can be presented to look more attractive than cash and stock markets, but is not necessarily so. The product is quite complicated in how it is structured and you don’t really partake in the upside either.”
P2p is fast becoming a significant alternative to cash and will be even more so soon when it becomes eligible for inclusion in tax-free Isas. The way in which peer-to-peer platforms work is to match savers and borrowers, cutting out the banks so that both sides enjoy better rates.
For a p2p investor, annual returns as high as 12 per cent are undeniably attractive, but ultimately you must once again be prepared to lose some, or even all, of your money. Platforms are now regulated by the Financial Conduct Authority (FCA), but there is still no FSCS protection.
Zopa has been around since 2005 but this is still a very new industry. Most platforms spread your cash to minimise risk, but each one has its own model so you need to get to grips with the individual perils. Aside from fees and, for now at least, paying income tax on returns as you do with normal savings, you need to think about what protection, if any, is in place. Zopa and RateSetter hold, respectively, a Safeguard Fund and Provisions Fund to cover borrowers who default. But this does dampen returns (currently around 5 per cent over five years).
Returns are generally higher if you lend your money to small businesses, as you can with Funding Circle, but this is inherently riskier than lending to individuals. Funding Circle is currently returning an average of 6.1 per cent, after bad debts and fees, but these returns are calculated before tax. That means you pay tax on all the whole lot, before bad debts have been taken away from your earnings.
The Swedish platform TrustBuddy offers an impressive 12 per cent return for its payday loan platform, but here you pay currency exchange costs and your money is scattered across borrowers in Denmark, Estonia, Finland, Norway, Poland, Spain and Sweden.
Other platforms specialise, which could leave you exposed if a particular sector struggles, Abundance Generation, for example, offers returns of 6-9 per cent for investment in ethical and sustainable energy projects in the UK.
Lenders such as FundingSecure (a P2P pawnbroker), Assetz Capital (loans to property developers) and ThinCats (business loans) also have their own variations on the peer-to-peer model.
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