22nd May 2015
Peer to peer (or “marketplace investing” as it is coming to be known) has been gathering a lot of momentum over the past few years, both in the UK and the US, and is quickly moving towards becoming a mainstream option both for borrowers and investors. There are a number of developments in this new industry’s coming of age that could potentially spell healthy returns for investors, many of which we’re expecting to see come to market in the next 12 months. It’s for this reason that we think every investor should be consider adding peer to peer investments to their portfolio in 2015.
P2P loans are serious business – across the UK it’s estimated that P2P loans in 2014 amounted to over £1 billion. In the US in December, the biggest P2P platform – Lending Club - launched an initial public offering on the NASDAQ at a US$5 billion valuation, quickly spiking to US$9 billion on opening day. 2015 is also the 10th year of trading for the world’s first P2P lender, Zopa; a London-based personal loans marketplace. Crowd2Fund is unique in that it offers both equity investing and debt finance, which allows investors to build a diverse portfolio in one marketplace.
As the industry matures, institutions, pension funds and investment houses have begun to invest, and on the other side of the coin the biggest borrowers are now also businesses, rather than individuals. For this reason the industry has begun to move towards the term “marketplace lending” or “marketplace investing”, reflecting a more all-inclusive nature for the sector. From facilitating personal loans between individuals ten years ago, P2P is quickly moving towards becoming an online bond and equity market connecting small businesses and investors of all sizes.
Aren’t These Just Payday Loans for Businesses?
Given the returns offered on some platforms, investors are right to wonder about quality. The level of diligence performed on each investment will vary from platform to platform, so it’s critical for investors to make themselves aware of the policy. Most platforms will do some form of vetting, with the best platforms employing underwriters alongside proprietary scoring models to reduce the chance of investment defaults. Before committing to an investment, it’s important to know how much of the work is done by the site and how much of it falls to investors. Investors should read the sites FAQ’s and understand the model.
Most platforms will make available to the investor financial statements, what the business does, and in some cases information about the directors and who they trade with, to allow investors to decide if they agree with the Underwriters decision. Quite often this is supplemented with credit ratings or links to third-party credit reference agencies.
Based on publicly available data, default rates across the commercial P2B loan industry have thus far been 1.5%, although given that the industry-wide lending book is mostly quite young, this can be expected to increase somewhat, potentially to something in the region of 2-4% depending on the platform and individual risk appetite. With rates of return for business loans in the region of 8-14%, investors should expect to earn a net return in the region of 6-10%.
Equity investments are nearly by definition more long-term and speculative investments, so statistics aren’t yet available for returns or default rates. They will generally target a 3-5 year exit, although in reality these are often pushed out or may not happen altogether. Such is the reality of early-stage business investment; high risk and high reward.
More so than with other investment strategies, it is particularly important to diversify with peer-to-peer investments, be they debt or equity. Whilst 9 in every 10 equity raising start-ups may fail, the 10th may be the next Uber or Facebook. In the debt markets, out of every hundred established businesses an investor lends money to, 2-3 of them may default before their final repayment. Rather than fear failure investors should allow for it, and responsible platforms will always recommend an investor diversifies their investments.
New regulations imposed on the P2P industry effective 1 April 2014 have also improved the level of clarity in promoting these types of investments, and additional regulations are expected to be put in place in 2015. Contrary to most industries, the P2P market generally have been supportive of enhanced regulatory oversight, as trust and a responsible marketplace are crucial factors in an industry that relies so heavily on its credibility with “the crowd”. Pay-day lenders can afford to lose their own capital, but peer-to-peer platforms cannot afford to lose their investor’s capital.
Points To Be Aware Of
Tax: Currently Peer-2-Peer investments are not eligible to be included in an ISA, although a consultation to create a P2P ISA was completed by HMRC on 12 December, 2014. It’s hoped that a new resolution will be put in place in time for the next budget. Inclusion within a SIPP is dependent on the acceptance of individual SIPP providers and mostly unlikely currently. So as it stands, profits on Peer-2-Peer loan investments are generally fully taxable. This of course is not the case for equity investments (details below).
Personal involvement: Some online marketplaces allow investors to choose their broad criteria for investing, and allow the system to spread your funds automatically across borrowers on your behalf. This reduces the amount of time the investor needs to spend in placing their money and allows them to just leave it ticking over. If this isn’t available, or investors choose not to rely on a system like this, marketplace lending will involve more management time on the investor’s part than traditional investing, both in placing the funds initially and occasionally re-investing returns.
Written by Craig Snider
