The next evolution
Peer-to-peer focused investment trusts have had mixed fortunes since their fruition, with some adapting their business models as a result. With many P2P platforms showing stratospheric growth, are the sector’s funds falling behind?
THE PEER-TO-PEER SECTOR has changed dramatically in recent years, from the rates on offer to the types of lending, but these shifts have also forced mainstream funds investing in the sector to alter their strategy.
So is it possible to profit from investing in P2P through an investment trust?
In 2014, the UK’s first P2P-focused investment trust P2P Global Investments (P2PGI) launched to much fanfare, offering a way for investors to take advantage of the burgeoning sector without having to risk their money on the actual platforms, while being able to diversify into various types of loans.
But just short of its three-year anniversary, P2PGI is yet to reach the six to eight per cent yield first offered to investors and manager MW Eaglewood is set to merge with Pollen Street Capital, after facing pressure from the board to boost the fund’s performance.
Pollen Street will become the majority shareholder of the combined group, with assets of around £2bn, while MW Eaglewood backer Marshall Wace will retain a substantial holding.
P2PGI had previously stated that it was shifting away from US consumer loans towards more asset-backed and trade finance, but the Pollen Street merger will also give the investment trust access to specialist finance outside of P2P.
The portfolio will have greater exposure to sterling-denominated assets and maintain exposure to “a tighter group of marketplace lending platforms”, P2PGI said when the deal was announced in May.
P2PGI is by no means alone, as other alternative finance-focused investment trusts have also altered their strategy due to the changing market.
Victory Park Capital (VPC) Specialty Lending Investments, which launched in March 2015, said in November last year that it was winding down its P2P portfolio in favour of balance sheet loans where returns are better.
This comes as many P2P platforms, particularly in the consumer lending space, have reduced their lender interest rates to compete for borrowers in the market.
As of March 2017, 32 per cent of the VPC portfolio was allocated to marketplace lending, down from 40 per cent in November 2016, while the amount in balance sheet loans increased from 48 per cent to 49 per cent over the same period.
VPC’s newsletter for the first quarter of 2017 suggests the strategy of winding down marketplace loans and investing in balance sheet lending would continue.
These are the two biggest investment trusts focusing on the sector, with P2PGI managing £813m of assets and VPC looking after £352m.
Both regularly post positive net asset value (NAV) returns and issue dividends, yet regularly trade at double digit discount to values – at 9.4 per cent and 11.8 respectively at the start of June – suggesting investors are still unsure.
Simon Champ, MW Eaglewood’s chief executive officer, insists there is no issue with investing in the sector and P2PGI is simply responding to the way the industry is changing, as P2P is no longer just about simple consumer or business loans.
“When we first had the idea of creating an institutional vehicle to give investors the ability to invest into disintermediated credit in 2014 the industry was quite narrow,” he tells Peer2Peer Finance News.
“We started life with four platforms in our portfolio. Today the P2P world has changed enormously. It has matured and given birth to many other types of originator.
“The line between a P2P loan originator and platform that originates loans, as well as balance sheet originators, has become more blurred.”
The downside of P2PGI’s initial pure P2P focus was seen when its share price fell seven per cent in May 2016 as investors panicked over its exposure to Lending Club, after questions over the platform’s lending practices resulted in the high-profile departure of its founder and chief executive Renaud Laplanche.
Champ insists the merger with Pollen Street would help manage the evolution of the sector.
Analysts have responded with interest to the new management arrangements, especially as Pollen Street already runs the Honeycomb Investment Trust, which focuses on UK specialist consumer and business lending.
“The review of management arrangements followed a period of disappointing performance from P2PGI and the changes are perhaps more radical than we were expecting,” says Ewan Lovett-Turner, analyst for Numis.
“The high exposure to US consumer loans in P2PGI had been a concern to us and it had been a drag on returns due to disappointing loan performance and complications due to currency hedging.
“MW Eaglewood had already started reducing exposure to the US consumer and we welcome the continued wind down of this area of the portfolio.”
Lovett-Turner thinks Pollen Street brings good experience, but adds: “It remains a relatively new vehicle and we believe the next six months will be important period for to determine how the Honeycomb portfolio performs as its loans mature.
“We expect the P2PGI portfolio to look significantly different in 18-24 months’ time and believe it will be important for the manager to maintain portfolio disclosures so that investors can understand their evolving exposure.”
While investment trusts such as VPC Specialty Lending and P2PGI have been altering their strategy, another player Ranger Direct Lending, launched in May 2015, has been doing well from a predominantly US focus.
Both VPC and P2PGI have around 60 per cent of assets in America with the rest in other countries such as the UK, Europe and Australia, but Ranger Direct invests primarily in US small business lending and is denominated in dollars, which has helped it avoid the travails of the Brexit vote.
Ranger Direct’s ordinary share class has seen its NAV return 33 per cent since launch up to the beginning of June 2017. In the 12 months to the start of June 2016 it has returned 17.3 per cent.
This compares with 2.36 per cent over the same 12-month period and 14.68 per cent at P2PGI since May 2014, while VPC’s NAV returned 2.58 during the 12 months to the start of June and 7.98 per cent since March 2015.
But the Ranger fund is also on a high discount to NAV of 24.9 per cent, which gives it the same problem plaguing VPC and P2PGI.
Champ says the high discounts are due to negative sentiment that makes investors panic, rather than an issue with the fundamentals.
“There are fragilities for investment trusts,” he says.
“They can be blown around off course by winds of sentiment.
“Sometimes your NAV growth can be reasonable, yet you look at the share price and you would think there had been a disaster. Sometimes that is just sentiment.
“That can be an issue with closed-end vehicles where the only exit is to sell shares.”
Other funds are showing that you can invest in P2P without trading at such big discounts.
The Funding Circle SME Income Fund (FCIF) was launched in November 2015 and is set up purely to invest in the loans of its own P2P platform.
That strategy seems to be working so far, as it is on a relatively small premium to NAV of 3.4 per cent and has seen a 6.93 per cent return in NAV since launch.
“The FCIF provides equity investors seeking yield exposure to a diverse portfolio of small business loans in the UK, US, Germany and the Netherlands,” explains Sachin Patel, chief capital officer at Funding Circle and non-executive director of FCIF.
“The fund, which is the first and only single-platform fund, has been one of the best-performing investment companies in the direct lending sector and targets a dividend yield of between six and seven per cent. It is unique in not charging a management or performance fee.”
Its dividend yield, currently at 5.8 per cent, is just under the debt sector average of six per cent.
Ranger Direct and VPC’s dividend yield, at 11.3 per cent and 7.3 per cent respectively, beat the average. P2PGI was on a dividend yield of 4.7 per cent as of the start of June.
Any investor would be happy with this sort of return on a stock or fund portfolio, yet mainstream advisers and fund managers still feel the sector is too niche.
Adrian Lowcock, of investment manager Architas, says higher risk and more adventurous investors are most likely to be interested in these types of funds but says there are good reasons to be hesitant.
“Given the growth and success P2P has had, it is easy to assume that the established financial market players are negative on the asset class because they are threatened by it,” he says.
“However, there is more to it than that. The sector remains relatively untested and hasn’t gone through a full business and economic cycle.
“Investors just don’t know how it would fare during a recession or downturn. In addition, the sector has also risen during a very unusual financial period when banks were struggling to lend, interest rates were very low and financial stimulus has given rise to huge amount of liquidity.”
Jason Hollands, of Tilney Bestinvest, which provides advisory and DIY investment services, says the sector works in theory but he feels it is just too niche and untested.
Ben Conway, of Hawskmoor Fund Managers, has been deterred from investing in this sector for similar reasons despite recognising that the investment trust structure is well-suited to accessing the sector.
“The permanent nature of the capital is ideally suited to investing in an illiquid financial asset,” he says.
“Moreover, the presence of an independent board of directors should give investors extra protection and safe-guard, to some extent, corporate governance in what is a nascent industry.
“However, ‘caveat emptor’ very much applies here.
“The sector is new and different business models abound. Some companies are led by entrepreneurs fairly new to the industry and others by more experienced lending professionals.
“Most importantly, we haven’t yet seen how any of the P2P trusts’ portfolios have fared during an impairment cycle.
“Due to these unknowns, our stance, to date, has been to avoid the P2P trusts altogether.”
Conway says they would never “blindly invest” just because the yield is attractive and there needs to be a margin of safety which P2P trusts are yet to provide.
Advisers may be hesitant but, as Champ explains, investment trusts like P2PGI are opening up “small ticket, unsecured consumer and SME lending” opportunities that were previously only available to the banks.
“We are giving equity investors access to an asset class they didn’t have before,” he asserts.
“It was a party only big banks were invited to.
“It just needs structure.”
This may not be where P2PGI or others thought they would be three years ago, but no-one could have predicted how the whole sector would evolve back then. Just as the P2P sector regularly changes, it is likely the evolution of the P2P investment trust will continue.