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Summary
- People who bought into the company’s burrito bond scheme might lose most of their money
- Chilango dining chain’s 12 Mexican cuisine restaurants on the verge of closure
- Re-evaluate your corporate bond portfolio keeping few tips in mind, given the corona pandemic scenario
In a recent phenomenon, investors are likely to lose millions of pounds into a “burrito bond” scheme after dining chain Chilango prepares to enter administration. The investors of the burrito bond scheme are reliant on proceeds from the sale of the company’s assets and could lose most part of their investment capital.
The chain is planning to close its twelve Mexican style dining outlets. Approximately 150 people are likely to lose their jobs as a result.
More than one thousand investors have collectively bought company’s bonds worth £5.8 million, through the burrito bond scheme that promised a return of 8 per cent per annum.
Quoting another similar incidence, the prominent Travel & Leisure company, Thomas Cook Group Plc was liquidated in the year 2019. As a result, the corporate bonds (denominated in Euros) issued by the company lost 66 per cent of their value. There are plenty of similar instances where the investors have lost a lot of money. Unfortunately, a lot of these investors are not able to take big risks.
Investments in bonds is generally taken up by the investors who have less risk appetite. Bonds are a quintessential choice when it comes to choosing debt securities for portfolio diversification. Corporate bonds are traditionally seen as a high-yield investment vehicle with lesser risk in comparison to other forms of investments. Investment instruments like pension funds and retirement funds also fall in the same category of moderate risk exposure.
The volatility in stock markets over the past few months due to the economic impact of the coronavirus pandemic has been threatening both corporate profits and business growth. However, experts believe that the biggest pitfalls lie in the bond market.
Can Covid-19 trigger a corporate debt crisis?
The short answer to this question is yes, there is a high probability of that! The UK’s economy is presently sitting on a debt pile. During the unprecedented crisis, the government has launched a lot of stimulus packages with credit moratoriums to help the businesses in the UK stay afloat.
Most of the businesses in the UK have resorted to these stimulus packages. During the lockdown, the economic activities came nearly to a screeching halt. This has resulted in drying up of revenue streams for the businesses. Businesses such as travel & leisure, aviation, automobiles, tourism, restaurants, and pubs have been hit hard in wake of the crisis induced by the pandemic. Moreover, the lessened economic activity and travel restrictions have led to the plunge in crude prices.
What are corporate bonds?
Buying a corporate bond essentially means lending money to a business. The business in return offers the buyer a series of interest payments until maturity. After maturity, the buyer gets the principal amount. Corporate bonds are considered a comparatively secured investment. Investors looking to balance their portfolio against riskier investments such as growth stocks could include corporate bonds in their basket. These debt securities are often endorsed by independent credit rating agencies.
As the risk-taking capacity of investors declines with age; to safeguard the accumulated capital, the investors tend to add more bonds and fewer riskier investments in their portfolio. Moreover, investors planning for retirement often tend to consider investing in bonds to supplement their incomes.
Technically, corporate bonds are riskier as compared to the government securities. Due to higher risk quotient, corporate bonds tend to offer higher interest rates than government backed securities. In general, the difference between the yields of government backed securities and highly-rated corporate bonds is known as the credit spread.
The biggest advantage of investing in a corporate bond is predictable income or cash flows unless the borrowing entity goes bust or defaults on its debts. The predictability of incomes is a nice feature to look at when compared with equity investments, which are highly volatile and unpredictable by nature. In addition, regular dividend pay-outs are not guaranteed. However, corporate bonds offer investors with similar coupon payments periodically.
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Another advantage of corporate bonds over equity investments is that they usually have a moderate risk profile.
Need to re-evaluate your corporate bonds portfolio as a result of the coronavirus pandemic
Given the prevalent conditions in the economy, the interest rates are at all-time low. People who are already invested in corporate bonds of businesses with resilient models would continue to enjoy higher interest rate coupon payments in the upcoming months as the interest rates in the economy are expected to be on a lower side for some more time. However, people who wish to park their excess money in corporate debt securities and make fresh investments must keep few things in mind before investing.
If the bond issuing company goes bust, corporate bondholders are higher up the queue to get back their money as compared to shareholders. In the pre-pandemic era, UK corporate bonds have generally done well.
However, things have evolved quite rapidly in the recent times. Given the prevalent conditions in the economy, investors should be wary of the instrument ratings endorsed by the credit rating agencies. Corporate bonds of companies operating in the worst affected sectors should be avoided as their revenue structure has almost collapsed due to the catastrophic impact of the novel coronavirus. The credit ratings of big businesses endorsed by reputed credit rating agencies could turn junk in a jiffy.
There are three principle risks when it comes to making an investment in corporate debt securities. First is the delay/ default of interest payments. If a company is not doing well, it can default or delay interest payments. The company can also default on the principal repayment. The bonds issued by the corporates are normally traded in the secondary market. During the tenure of bond subscription, if an investor needs the money back, he should be able to trade the bond. However, an investor might face some liquidity issues in the prevalent circumstances.
To summarise, a prominent dining chain Chilango is expected to go into administration. This has brought shivers to hundreds of investors who have invested into the company’s burrito bond scheme. There is a need to re-evaluate the corporate bond portfolio, given the uncertainties arising out of the corona pandemic times.
