Already one of the fastest growth areas in financing, peer-to-peer lending has recently seen the launch of a number of investment trusts. Will investors and businesses both reap the rewards?
The past seven years haven"t exactly been the best time to be an SME seeking funds. Since the financial crisis, banks and other traditional lenders have tightened their lending criteria and avenues have become closed off as regulators restrict lending activities to help stabilise the economy.
Against this backdrop, the surging appeal of peer-to-peer (P2P) lending comes as no surprise - while the banks may not be in a position to dish out the dosh, plenty of other folk are.
The P2P model is largely credited to Zopa, a London-based platform that launched back in 2005 and has now lent more than £1bn. The basic model of P2P is that online platforms allow individuals and businesses seeking capital to go direct to members of the public, who in turn get a good return for their lending (much better than the paltry interest rates that are available from deposit accounts).
Zopa has since been joined by a host of rival platforms, including Funding Circle, through which 11,000 businesses have borrowed a total of more than £890 million in the UK alone.
Overall, P2P lending to British firms exceeded £1.2bn in 2014, with a 90 per cent increase in the number of UK companies borrowing through such platforms, according to the Peer-to-Peer Finance Association.
“There"s strength and wisdom in the crowd,” says Angus Dent, CEO of ArchOver, a UK-based P2P lending platform, as an explanation for P2P"s success. “Borrowing becomes easier for the borrower, while we build in several layers of security for lenders.”
Of course, such revolutionary models rarely remain static for long, and the P2P concept has now expanded beyond one-to-one lending through the creation of P2P investment trusts, which manage a selection of loans on the investors" behalf. By investing in a range of P2P platforms, these offer exposure to a greater number of loans than if investors used a standard P2P model.
They may also offer exposure to debt that may not be directly accessible through P2P lenders, and they have a potentially low correlation to equities - which could make for an attractive risk profile. Plus, with dedicated teams to choose the loans, it saves investors doing their own due diligence on the underlying loans and platforms, which can be both tricky and time-consuming.
This is a relatively new asset class, perhaps more accurately labelled "direct lending" - it"s hard to see an investment trust as a peer, but the P2P title has stuck because the process remains intermediary-free. While retail investors were targeted first, it"s now largely the preserve of institutional investors such as pension funds - which means far greater fund volumes and chunkier deals.
Branching out
At the time of writing, there are five investment trusts in this space. The largest, P2P Global Investments, launched in May 2014 and has so far raised around £800 million. Victory Park Capital and Ranger Direct Lending are US companies that launched in March 2015 and have raised about £200 million and £135 million respectively to date.
But the Channel Islands are involved as well, first through GLI Finance, which has a Guernsey-based P2P investment trust that has allocated a £52 million fund across 19 platforms.
“We"re director of all of them, so we have full oversight of the businesses,” says Andrew Whelan, GLI"s Director of Lending. “We"re intimate with them, rather than just using them as a vehicle to throw money through, and we"ve created a liquidity in the fund - investors can redeem up to 20 per cent of the fund every six months with 90 days" notice at a price discount to NAV of 0.5 per cent.”
Finally, there"s the news that Funding Circle has launched an investment trust of its own, making it the first platform to do so. The Funding Circle SME Income fund, which is also based in Guernsey, listed in London in November, after raising £150 million from a group of institutional investors. It"s set to focus on loans to small businesses in the UK, US and Europe.
Investor gains
So exactly what"s in all this for the investor? P2P investment trusts bring several benefits - one is yield, which is proving so elusive in the current climate. A pension fund that doesn"t have to worry about the kind of regulation that"s stifling bank lending may wish to get involved as P2P investment trusts are paying between six per cent and 10 per cent. Funding Circle"s trust targets a yield of about seven per cent a year.
The other principle boon for investors is diversification, which helps boost security and lower risk.
“Investment funds allow instant portfolio diversification,” says Dent. “If you"ve only got £1,000, you can"t spread that around on our platform - but put it into a P2P investment trust and you can.”
And what about the borrower? “Institutions are where a lot of the cash is, and these funds are doing a good job by unlocking it and getting it out there to help businesses,” says Dent. “That"s way better than leaving the money sitting in deposit accounts not doing anything.
“If you"re an engineering business in the West Midlands in need of £200,000, do you really care where it comes from? You don"t want to get it from a drug dealer, so it needs to be reputable, but beyond that you"re not fussed.”
Such platforms also benefit borrowers with speed. If you have the opportunity to buy a property for development, but you have to complete on it in a week, for example, there"s little chance a bank could turn it around in the timeframe required.
“With these guys [P2P lending], you may pay an arrangement fee,” says Ben Thomason, Managing Director at Asset Leverage Consultants. “But as you"ve managed to buy the property and refinance it quickly, it"s still worthwhile.”
While luring powerful institutional investors is a quick way for a fund to hit its targets, P2P trusts are still suitable for individual investors too. They have been eligible for inclusion in individual savings accounts (ISAs) in the UK since July last year - and from April, the first £1,000 of direct peer-to-peer earnings will be tax-free, at least for lower-rate taxpayers.
Buyer beware
It"s no surprise then that retail investors are tempted to get involved. But they should beware: these yields are high for a reason. P2P investment trusts come with the risk of default of the underlying holdings. As Thomason points out: “Anyone hoping to get double-digit returns is operating at the higher end of the risk spectrum.”
Meanwhile, as P2P is a new form of lending, established after the financial crisis, these platforms haven"t been put through their paces yet. If the economy tanks further and jobs go, those defaults could shoot up. Ultimately investors will be reliant on the platform acting in a sensible way to mitigate against this.
Dent points to one problem here - the focus for fintech lenders is often more on the technology than on the money lending. And as we"ve learned quite painfully in the past, while tech is a great enabler in terms of finance, a whizzy bit of computer power isn"t going to protect anybody once things go wrong.
As such, the trust"s risk management has to be bulletproof, or as close to that as possible, and providers must be quick to act should any security be eroded, in order to get money back to investors.
Luckily, such platforms have a good track record in that regard. “One of the advantages of investment funds is that they have deep pockets,” says Dent. “When [GLI"s] Platform Black had a problem, GLI stepped in and financed the business through that period, using some of their funds to ensure people who"d lent over the platform didn"t lose money. They had the cash sitting on the balance sheet ready to go should a crisis arise.”
Still, while the providers may have systems in place to mitigate risk, it"s still a huge leap of faith for potentially unsophisticated investors simply chasing yield. “My concern is that if you"re a smaller investor with £5,000, and you think you"ve found a fund you can stick into your ISA, do you fully understand the risks?” says Thomason. “You have to be very careful that you choose the right fund - you have to know its quality, its track record and its risk assessment.”
It"s for this reason that P2P investment trusts could be a potential growth area for the Channel Islands - not only in the setting up of trusts, listing on the CISE perhaps, or using the Channel Islands to list in London, but also in their administration.
“Investing in investment trusts is a process that needs to be professionally managed,” says Whelan. “If you"re using client money, you have to ensure that you"ve managed it accordingly. That"s administration, which is absolutely a growth area for the Channel Islands.
“In fact, GLI"s administrator is in Guernsey, so by supporting them, we"re ensuring that money goes back into the local economy.”