We show our loyalty to various companies and brands in a plethora of ways – from reward cards at supermarkets, to buying T-shirts and key rings of our favourite sports clubs.
Such behaviour reveals our preferences, but also – and importantly – benefits the selling or issuing company, whether directly through merchandise sales or indirectly through the ability to target promotions and understand consumer behaviour. Critically though, all of these are relatively transparent and straightforward approaches to monetising loyal clients. In particular they do not require any level of financial sophistication from the underlying client base (other than perhaps, understanding the basics of credit cards if issuing a branded credit card). The buyer, therefore, should have no unpleasant surprises.
This is not, however, the situation when companies issue bonds. Now of course the market for corporate bonds is long-standing and the average purchaser is an experienced, professional investor. So I am certainly not bemoaning the global industry that is professional fixed income investing – indeed, this is precisely how I access the world of corporate debt, as I would much rather leave it to the professionals than do it myself. However it seems that not everyone believes that this is the right approach. What we have seen increasingly in recent months and years is the direct targeting of corporate bond issuance at individuals, and particularly those with a pre-existing loyalty to the issuing company. The rise of these so-called ‘retail bonds’, many of which are oversubscribed, is clearly driven by consumer demand. That said, is it really fair to ask for caveat emptor or should we be more careful in educating individuals as to the risks, and benefits, of such investments?
I see two major problems with retail bonds. First, that individuals suffer from the behavioural problem of thinking that they understand businesses simply because they frequent them. This can give rise to an irrational level of confidence: for example, my local Jessops looked crowded until the day the business ceased trading. In other words, the financial status of a company cannot be understood simply by observing it from the outside. The reason we pay corporate bond analysts high salaries is because understanding a business’s financial position, and the likely direction of that company, is imperative in forming a worthwhile conclusion on the business’s creditworthiness. There is a real risk that an investor buying a retail bond will assume that the business is sound and likely to remain solvent, when this might not necessarily be the case. All this irrespective of outward appearances.
Second, and crucially, the ‘interest’ on these bonds does not always come in cash. Part may be in the form of loyalty or rewards points – bonuses. These are difficult to quantify in terms of value, not least as the business model is likely to assume much less than 100 per cent usage of any such ‘reward’, but also because there may not be precise cash value attributable to a given number of rewards points or similar. So, in reality, what is being offered can be a low cash value of interest with an unquantifiable, or at least uncertain, additional premium. And, worse still, if the business were to cease to trade, not only would the capital value of the bond be destroyed, the value of those points would also fall to zero. Futhermore it is safe to assume that a great many would be spent well after the point of issue (payment), which in itself means that such points must be ‘present valued’ to really understand the coupon being paid.
