By Trevor Clawson.
Peer to Peer (P2P) lending may be one of the newest kids on the investment block but according to new research from AltFi, it is paying out handsome returns.
P2P lending arrived in the UK back in 2010 with the launch of Funding Circle. The idea was simple. In the wake of the financial crisis, banks were – and still are – paying abysmally low rates of interest to savers. P2P platforms allowed savers to collectively lend money to businesses and individuals, usually over relatively short periods of time. By cutting out the middleman (or to be more precise, banks and other traditional lenders), P2P lenders were able to offer competitive rates to borrowers and superior returns to investors.
The market has evolved over the years. AltFi – which provides specialist news for the alternative investment industry along with a range of analytics services – says the market is growing rapidly. For instance, in 2015, P2P lending platforms brokered around £1.1bn in loans. In the first half of 2018 alone, the figure was £3bn. Separate figures from the Peer to Peer Finance Association reveal that its members have, to date, originated loans to a value of £9bn.
As P2P lending platforms have proliferated, there has been a considerable amount of specialisation. Many are open to a broad spectrum of investors, ranging from private individuals on relatively modest incomes, seeking a way to make their money work a bit harder to institutions, such as pension funds. Some platforms focus on wealthier investors or specialise in certain sectors, such as the property market.
Beating the Market
According to AltFi Data’s Lending Returns Index, P2P platforms delivered a return of 18.92% to investors between June 2015 and June 2018. Based on an analysis of data from Funding Circle, Market Invoice, Rate Setter and Zopa, that figure has been calculated after factoring in losses and fees. The average return not only compares more than favourably to the average returns from bank savings accounts that typically offer 1.5% per annum or less (even after the Bank of England’s hike in rates) but also with the more rarified forms of investment favoured by professional investors.
AltFi cites the example of the M&G Optimal Income fund, which returned a premium of 12.6% to investors over the same period. Overall, the report says that P2P returns outperform many large investment funds and bond investment opportunities.
The target interest rates advertised by some of the leading P2P platforms confirm that the returns from P2P offer attractive returns. For interest Funding Circle currently targets a return of 7-8% per year for its investors. Zopa targets 4.5% per annum for low-risk loans and 5.2% for those who are happy to live with a slightly riskier proposition.
A Lot of Variation
However, the returns enjoyed by investors do depend on the performance of the loans and as Uma Rajah, CEO of prime property focused platform lender CapitalRise observes, returns vary from 2% to 12% per year, depending on the platform.
“The rate of return depends on a lot of factors – the level of risk, the creditworthiness of the borrower and the purpose of the loan. That’s why annual returns can vary so much from platform to platform.”
A Safe Investment
But given that high returns are available, should the ordinary saver (aka ‘retail investor’ in the parlance of the financial services industry) be rushing to take money out of his or her easy-access savings account and put it instead into a P2P platform?
Investing via a P2P platform is a relatively simple process. The platforms in question are essentially online marketplaces that bring together prospective borrowers with investors who have cash they are prepared to lend in concert with others. For its part, the platform vets those who are applying for finance – assessing their creditworthiness – and then presents a range of loan propositions to prospective lenders. Every platform works a little differently but in most cases, the loan opportunities will be rated in terms of the associated risks and an interest rate is set accordingly. Generally, investors, have the ability to choose a particular loan opportunity but some platforms ask for funds to be pre-committed and the platform itself makes investment choices and funnels that cash to borrowers. In an ideal world, investors lending through a platform can choose a rate of return that aligns with their own appetite for risk.
Despite the success of P2P, there are still some question marks over its suitability for ordinary investors, as highlighted in July by the industry regulator, the Financial Conduct Authority (FCA). While the regulator has been broadly supportive of ‘alternative finance’ it has expressed concerns that some platforms are not providing sufficiently accurate or transparent information about investment opportunities on offer. So under proposed new rules, all P2P platforms will have to be much more open when it comes to disclosing information on interest rates (real and expected), default rates and the risks associated with each loan.
The FCA is also calling on platforms to tighten up their approach to marketing, saying that some lenders were being exposed to opportunities that fell outside their stated risk comfort zone. More controversially – at least within the industry – the regulator is also proposing that the marketing of some P2P products be restricted to ‘sophisticated investors’ – or to put it another way, individuals who tend to be wealthy and can demonstrate that they are financially literate.
It would be wrong to suggest that P2P investing is unacceptably risky – as the AltFi research indicates, the returns after losses remain high. But the reforms should provide an added safety net and have been broadly welcomed by the industry as a positive step. As David Bradley Ward, CEO of the P2P platform, Abirate put it:
“For the P2P lending industry to grow further, it needs to be effectively regulated. In short, this means there’s a fair playing field for lenders, borrowers and platforms. FCA regulation has cemented peer-to-peer lending as a mainstream financial service but to reach its full potential the industry must ensure best practice at a time when the FCA is seeking the adoption of good practice.”
Uma Rajah points out that there three different categories of lending – consumer, business and property – and each have their own risks associated.
“Loans to SMEs and consumers are usually unsecured,” she says. “What this means, in a nutshell, is that should the borrower be unable to repay the loan, investor capital is lost. Property loans, on the other hand, are secured against the properties themselves with a legal charge. The easiest way to understand this is to imagine that should the borrower be unable to repay, the lender (or lenders) could seize the property and force its sale in order to recoup their capital.”
P2P Lending is now part of the mainstream. The Altfi report suggests that it is delivering consistently high returns. But the opportunities and risks vary according to the platform and the nature of the loan.