I MAY EARN MONEY OR PRODUCTS FROM THE COMPANIES MENTIONED IN THIS POST.
Peer to peer lending is an expression you might have heard here and there over the past 8-10 years, and maybe increasingly so. I have myself been using P2P lending in my portfolio for a couple of years, with Crowdcube (small businesses and startups), Funding Circle (small loans to companies) and Lendinvest (mortgages). How does it work and how can it fit in your investment strategy?
1) What is peer to peer lending?
As the name suggests, peer to peer, or P2P, also referred to as direct lending is a way of financing a business without the usual intermediary: a bank. In the world of personal finance, the 2 Ps in P2P are you, the individual investor, and the business/asset you want to invest in. No bank is involved. Instead, a platform connects individuals and business and conducts the due diligence on both sides.
For many years now, banks have mastered the two end of the borrowing spectrum:
-very small loans for individuals: student or car loans, which you can discuss with an advisor and get an answer in a decent amount of time.
-large loans in different forms for institutions. Businesses securitise their lending using their assets.
Small and medium-size enterprises are somewhere lost in the middle and banks have not found this part of the spectrum to be profitable. Consequently, customer service is not as good as it could be, and business will look elsewhere.
P2P platforms noticed that and are exploiting the opportunities. Usually, with the help of technology and big data, they are better suited to approve loans in a shorter timeframe and are cheaper than banks, freeing more return for investors and less interest for borrowers.
It’s important to note that each platform has its own model and expected rate of return. For instance:
Lendinvest: mortgages, between 4-7% annual interest
Funding Circle: SME, up to 7%
Crowdcube: ?% because you are most likely helping a startup and your capital will not be returned for a few years.
2) What are the risks and what guarantees exist
Again, because each platform is different, risk and guarantees will differ, and some platforms/models are better than others. It’s up to you to investigate the market and find what you are comfortable with. Funding Circle, for instance, has high requirements from businesses and grant loans that represent a small portion of the expected revenues, so that the money can be returned even in an adverse environment. Funding Circle also uses big data to predict market environments and avoid sectors that are likely to perform badly in future months or years.
Lending Work and another platform also have a fund to cover bad debts. This is bad practice in my opinion as this puts the platform itself exposed to the risk of a bad market environment.
3) How does it fit in your portfolio?
Before putting your money on any P2P platform, need to decide whether you are comfortable with this type of investment. Do your homework and research the market. I have found this Telegraph article from 2016 that summarises the platforms available in the UK.
I also believe that P2P lending should be diversified for two reasons: a lot of these platforms are new and need some time to prove that they are resilient (or not), the exposure you get from only one platform will likely be correlated as platforms usually specialise in a certain type of borrowing. In term of risk and return, most investments will behave like a corporate bond: bringing you regular return above a savings account, with your capital at risk.