Six alternative ways to invest in debt
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Debt investment can offer you some great ways to diversify your portfolio. Take a look at six different types of alternative debt.
Alternative ways to invest in debt
There’s nothing new about debt investment – many smart investors have been using it as a way of diversifying their portfolios for a long time now. This is especially the case for investors who are either risk adverse, or prefer to mitigate a lower level of risk for an expected higher rate of return.
As people have become increasingly comfortable with equity as a means of investment, many are now looking to debt as a great alternative to diversify their portfolio. Debt financing allows investors to continue supporting the growth of strong UK SME businesses whilst benefiting from potentially lower risk and higher returns.
There are several different debt investment instruments ranging from factoring and corporate loans to consumer and micro loans. Each offers varying levels of return and risk, but all can form part of a well-balanced portfolio of investments especially for those heavily invested in equity. Here’s six to consider:
Factoring involves buying the accounts receivable owed to a company at a discounted rate to the amount that’s owed. A factor can pay the seller of the debt between 60-80% of the amount owed depending on the creditworthiness of the debtor. The factor then attempts to collect the full amount owed by the debtor. An investor in factoring is actually investing in the debt that’s owed to the secondary creditor – the factoring firm.
2) Corporate Bonds
A corporate bond is a debt based funding arrangement set up to fund large capital expenditures and/or operations that a small or medium business may otherwise be unable to access. This is the primary way we at CODE assist growing SMEs to raise investment capital.
Investors in this asset type are investing directly in the business via a marketplace that sources the opportunity and applies due diligence processes beforehand.
Corporate bonds can take several forms including secured and unsecured bonds as well as convertible and non-convertible bonds. We assess each individual business with a due diligence process that allows us to ascertain whether the company could be a sound investment opportunity for our discerning network of private, high net worth, sophisticated and institutional investors.
3) Consumer Loans
Consumer loan platforms, like Lending Club are a form of investing in debt where the capital invested is lent to private individuals rather than a business opportunity.
The platform lends the capital invested in their debt to consumers as an alternative to small bank loans or credit cards. The investor then earns profit from the interest rate on the loans. The criteria for borrowers tends to be high with some platforms having a ratio of less than 10%of loan applicants being approved.
4) Micro Loans
Micro loans as the name implies are small loans which can start as low as £100 and can range into several thousand. Borrowers are generally small business owners or entrepreneurs from developing countries who would otherwise be unable to gain loans from banks or other traditional lenders.
Investors in this type of debt tend to do this for more altruistic reasons such as helping low income borrowers a way to get their businesses off the ground. Saying that, platforms such as Kiva, a non-profit organisation offering micro loans boast a loan repayment rate of 98.8% as of 2011.
5) Unsecured business loans
This type of debt investment involves lending to businesses to enable their growth and expansion. Loans can vary from a few thousand pounds up to several hundred thousand.
Platforms such as Funding Circle provide a marketplace matching investors and borrowers. Credit risk is assessed by the platform who set an interest rate accordingly. Investors then choose to invest in a portion of such a loan and receive interest and principal payments back over the lifetime of the loan. This type of loan can have a term of between 6 months and 5 years.
6) Bank Accounts
Lending money to a bank via a savings account produces a low return, losing investors money after inflation is taken into account. However, investors money is safe, as bank accounts which are part of the FSCS are backed by the government up to a maximum of £85,000 per bank invested in.
Which form of debt is best to invest in?
This of course depends on what your investment goals are and how much you want to invest. Some forms of debt such as corporate bonds “lend” themselves more towards larger investments and higher returns than micro loans for example which may better suit your aims if you’re more interested in doing social good for low income borrowers.
Whichever form you choose, debt provides an alternative for investors seeking other opportunities and means to diversify their investment portfolio.
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The CODE Investing UK Investor report examines the growing trend in lenders supporting loans as a preferred way of financing small businesses.
The latest banking report highlights that around half of SMEs are aware of the alternative finance options
Banks may be reluctant to lend to SMEs until the “Brexit fog” has cleared, but that’s not stopping business lending from alternative sources.
Investing in early stage businesses involves risks, including illiquidity, lack of dividends, loss of your investment and dilution and it should be done only as part of a diversified portfolio. CODE Investing Limited is targeted exclusively at investors who are sufficiently sophisticated, or who are judged by CODE Investing Limited otherwise to be appropriate, to understand these risks and make their own investment decisions. You will only be able to invest with CODE Investing Limited once you are registered as sufficiently sophisticated or otherwise appropriate for these types of investment. Investors via CODE investing are not protected from loss by the Financial Services Compensation Scheme against the Company’s default or for any losses they may suffer. Please read the full risk warning for more information. This page has been approved as a financial promotion by CODE Investing Limited, which is authorised and regulated by the Financial Conduct Authority. Investments can only be made on the basis of information provided in the pitches by the companies concerned. CODE Investing Limited takes no responsibility for this information or for any recommendation or opinions provided by the companies.
Tax Wrappers note: Innovative Finance ISA (IFSA), Self Invested Personal Pension (SIPP) and Small Self Administered Scheme (SSAS) : eligibility depends on an individual’s circumstances and is subject to change in the future.