Spot the difference
Crowd bonds occupy the same space as peer-to-peer loans, yet they are almost completely different. Or are they….?
WHEN THE Innovative Finance ISA (IFISA) was first introduced in 2016, it provided individuals with the opportunity to gain tax-free earnings from their peer-to-peer investments. But later that year, the Treasury opened up the wrapper to include debt-based securities such as crowd bonds.
Many industry figures have spoken at length about the differences and similarities between crowd bonds and P2P loans. Yet there is still a fundamental lack of understanding around the two investment products, which share a home under the IFISA tax wrapper.
The differences largely come down to regulation and access to diversification – two issues which any investor should prioritise.
“I think investors do understand the difference between crowd bonds and P2P loans – or at least the more experienced ones do,” says Jake Wombwell-Povey, chief executive of direct lending investment manager Goji. “And I actually think that crowd bonds and P2P loans arequite similar from an economic point of view.”
It’s true that the returns offered by crowd bonds and P2P loans are largely the same – in both cases, target returns start at around three per cent and can rise above 15 per cent, depending on the risk attached to the project. Likewise, in both crowd bonds and P2P loans, investors can choose to either fund individual projects or diversify across multiple loans, although admittedly it is easier to diversify through P2P than via crowd bonds.
“Investors either invest into a single project or they invest into a range of projects,” explains Wombwell-Povey. “So if you look at Zopa or Funding Circle – they do diversified lending, while other P2P platforms operate on a project-byproject basis.
“If you look at crowd bonds, it’s pretty similar – Downing does single projects, but they also do things like Downing Development Finance, which lends to a number of different projects. And in both cases, fundamentally the investor is investing in a project and the yields that come from that.”
Neil Faulkner, founder of P2P analysis firm 4th Way, agrees that these fundamental similarities can make it difficult to break through the confusion that retail investors may feel when deciding whether to put money into P2P loans or crowd bonds.
“Neither ‘crowd bond’ nor ‘P2P loan’ are regulated phrases,” he says. “If you show me a non-convertible bond in this space, I can probably find you a loan that works in the same way, as far as investors are concerned, including the risks, the maturity, repayment frequency, interest rates, secured/unsecured, and so on.”
So where do crowd bonds and P2P loans differ? It seems to be a matter of regulation, diversification, and loan origination.
Some relatively young crowd bond platforms won full Financial Conduct Authority (FCA) approval before longer-established P2P platforms. But this had less to do with favouritism and more to do with the simpler regulatory structure of crowd bonds compared to P2P loans.
While both types of products are regulated by the FCA, crowd bonds are also subject to extra scrutiny. For instance, in January 2018, all EU-based crowd bond firms became subject to MIFID II, which requires all platforms to issue potential investors with an ‘appropriateness test’, and to adhere to certain capitalisation requirements. Interestingly, in its recent consultation paper, the FCA suggested that these same rules should also be applied to P2P platforms.
And then there is the confusing issue of Financial Services Compensation Scheme (FSCS) protection.
“The same phrase – FCCS – is used for both deposit protection in a bank and investment protection for MiFID firms such as ourselves,” says Bruce Davis, co-founder and director of crowd bond provider Abundance. “It’s very confusing and we’re always challenged a bit in how we can talk about it in a way that is compliant – what is protected? It is the platform rather than the investment.”
However, Davis adds that variation in the regulation should not be the driving force behind an investor’s decision to invest in crowd bonds rather than P2P loans.
“The main decision should be: what is my money doing and how am I getting my return, and what’s the risk of not getting my capital back?” he says.
For most crowd bond investors, the attraction lies in the target returns and the type of project that is being funded. Several platforms have opted to focus on ethical or green investment opportunities, where investors are invited to help fund clean energy and socially aware projects.
According to TGI data, approximately seven million investors consider themselves to be altruistic or socially motivated investors, and this represents a significant portion of the UK’s overall investor community.
The Amberside Asset Lending Platform invests in high-yielding private debt in infrastructure projects, including solar parks, grid support facilities and hydroponics projects. And at green lender Abundance, investors can help fund clean energy projects such as hydro-power and geothermal plants. Last summer, ethical bank Triodos used crowd bonds to help fund one the UK’s largest solar panel projects.
However, with the vast majority of these bonds, investors can only invest in one project at a time. This flies in the face of the number one rule of investment management: diversification.
“Diversification is one of the barriers to growth,” says Davis. “If we want to be a significant part of what people are doing with their money then we need to offer a range of different risks on a range of different investments, and I think that’s the case across the whole industry.”
Davis adds that diversification is the main request from Abundance’s customers, who want to see more projects being promoted, and more variation in the types of projects that they can invest in. Of course, investors are free to split their money across several projects at a time, but this is a stark contrast to the 100+ loans that can be accessed through a P2P platform with an auto-lending function.
Diversification is going to be hard for crowd bond providers to achieve, at least until they can scale up to the point where they are issuing scores of new loan opportunities per month – a prospect which would require a huge investment in loan originations, credit checks and marketing. But instead of competing with P2P lenders on a like-for-like basis, crowd bond providers seem to be focusing on what makes their offerings unique.
Crowd bond providers have clearly demonstrated that there is plenty of room for innovation in the space. Downing Crowd broke new ground in 2017 when it launched two regular access bonds – The Bagnall Energy Regular Access Bond and the Pulford Trading Regular Access Bond – which allow investors to withdraw their money before the 10-year maturation date.
Meanwhile, positive investing platform Lendahand Ethex has combined real-world altruism with inflation-beating returns; generating five per cent per annum by creating solar panels for 2,500 rural Rwandan households. And Crowd For Angels has set itself apart by offering short-term crowd bonds, with a maturation period of just one or two years.
These are unique selling points that will certainly appeal to a lot of retail investors, who prioritise innovation and returns over instant diversification. In fact, with an annual IFISA allowance of £20,000, there is no reason why investors should not diversify their own IFISA portfolios, by spreading their allowance across a mix of bonds and loans.
Frequently, the differences between crowd bonds and P2P loans come down to sheer semantics.
“Platforms usually have their own marketing standpoint that puts unique or special benefits on their offer purely because of what it is called or how it is structured,” says Faulkner. “While it is usually just a marketing difference, the platforms can get quite irate and typically insist there is a real, substantial difference from an investor’s point of view, because they call it a bond or they call it a loan or a debenture.
“But despite their protestations, frequently the only difference for investors in reality is the word they choose to use. We don’t consider what platforms are calling their products to be of any use. It’s how it works that matters.”
Wombwell-Povey believes that investors should focus less on the type of product that they are investing in, and more on the expertise behind each platform.
“What it depends on is the quality of the manager,” says Wombwell-Povey. “Investors should be interested in not only the returns but what the underlying loans are.”
In this sense, crowd bonds and P2P loans are practically identical – in both cases, investors need to look past the returns, the diversity of offerings and the regulatory structure, and focus on doing detailed due diligence on each individual project instead.
This article featured in the June issue of Peer2Peer Finance News, now available to read online.