Peer-to-peer investing can provide great returns that are uncorrelated to the volatile stock market. So why are independent financial advisers still wary? Marc Shoffman investigates
INCREASING LOANBOOKS and rising Innovative Finance ISA investment suggests peer-to-peer lending platforms are having no issues attracting users, but the independent financial adviser (IFA) market still seems to be a tough nut to crack.
On paper, P2P lending should be attractive to financial advisers. Clients get inflation-beating returns that are uncorrelated to the stock market.
But IFAs still need some convincing. Anthony Morrow, chief executive of advisory firm OpenMoney, says he is wary of the level of defaults. “Small- and medium-sized enterprises (SMEs) going to P2P lenders will have almost certainly been turned down by their bank who, even if their credit underwriting has got tighter, still needs to lend,” he says.
“Therefore, they are automatically into the less-than-prime category. “There is only a certain number of borrowers, and certainly good ones, available to lend to.
“Add in the need for higher rates of interest that lenders need to offer to remain competitive, and the risk levels required start to increase further adding likelihood of defaults.
“Even the well-established, reputable P2P lenders such as Zopa and Funding Circle are a fraction of the size of traditional banks and therefore do not have the portfolio capacity to endure losses, let alone heavy losses.”
Meanwhile, other industry onlookers suggest that the disconnect is due to the time required to properly understand the platforms and the investment opportunities on offer.
“The resources and knowledge required to conduct due diligence on platforms can be hugely time consuming and is therefore off-putting to many IFAs,” says Anthony Carty, group financial planning and business development director at Clifton Asset Management.
“Fingers have also been burnt in the past around so called ‘alternative investments’ such as unregulated collective investment schemes. This has led IFAs to tread more carefully in this area – particularly as P2P has yet to travel through a full economic cycle.”
Victoria Hicks, financial planner for consultancy City & Capital, warns that without in-depth knowledge of an investment type, the risk is deemed as too high for advisers.
“Financial advisers carry the burden of liability, which in some cases can last indefinitely,” she says.
“When advisers are making a recommendation to a client, they need to ensure that what they suggest is risk-appropriate, and the client has the appropriate capacity for loss. “They also need to think about the risk to their business when recommending something they are accountable for.
“Most IFAs have at their disposal a researched panel of risk-appropriate investment options and are often guided by this. “Much work goes into the due diligence of recommended options and including a new ‘asset class’ means much work at firm or network level, followed by the training of those advising clients.
“Therefore, there is a great deal of work to undertake once a client has been assessed as being appropriate for P2P, in order to build confidence and understanding.”
However, there are changes afoot. New Financial Conduct Authority (FCA) regulations coming into effect in December will require P2P platforms to be clearer about their underwriting processes, as well as their historic and anticipated defaults, which will provide another layer of transparency.
Platforms must also introduce appropriateness tests and marketing restrictions, in order to protect retail investors.
Will this reassure advisers? P2P lenders certainly hope so. “We have not advertised to IFAs, however some use our platform,” a RateSetter spokesperson says.
“We expect that advisers will become a big part of investing in the future. The forthcoming stronger regulation is positive for advisers as P2P investing will be regulated on a par with other mainstream saving and investment options – the new rules confirm that P2P lending has become a mainstream investment and it is now a logical component of everyone’s diversified investment portfolio.”
Greg Carter, chief executive of business P2P lender Growth Street, predicts IFAs will become a cornerstone for the platform. “In such a volatile time for the stock market, we think IFAs will be relieved to be able to provide an alternative solution to their clients – many of whom might have felt like they’d run out of options,” he asserts. “At the same time, having a chunk of cash just sitting in the bank earning next to nothing can be frustrating.
“We see the IFA market as a key growth channel for Growth Street, in particular over the next two years. “Understandably, IFAs have been slower to take up P2P than direct investors. However, as the sector matures and they become more familiar with the different products and propositions, I see it becoming a core part of their service offering.
“Of course, the new regulations being introduced should play an important part in bringing P2P into the scope of financial advisers.”
However, sources at several other P2P lending platforms say it is not worth the time and effort to try to convince advisers, when there are plenty of funds coming directly from individual investors and institutions. Separately, Michal Brzozowski, head of operations for P2P technology provider Goji, says the new rules mainly target direct investors rather than advisers.
“Whilst the new rules will undoubtedly add consumer protections, they’re specifically geared to address the retail investor market rather than being something advisers will view as directly beneficial,” he says.
“Advisers will be deciding on their clients’ suitability and appropriateness themselves.”
He says advisers tend to be more focused on liquidity in the asset class, a lack of Financial Services Compensation Scheme (FSCS) protection, issues surrounding professional indemnity cover and yields being too similar to listed vehicles such as investment trusts. One platform that is more optimistic about IFA relationships is Octopus Choice.
The P2P property lending platform has managed to leverage the relationships it had with advisers from the venture capital trust side of the Octopus group. As a result, two thirds of its current book comes from advised customers, with numbers expected to rise. “At Octopus, we have seen that it’s vital to spend time with advisers face-to-face to speak through applicable client scenarios, how the product works, how to assess client suitability and what the experience will be like for the adviser,” says Charlie Taylor, head of Octopus Choice.
“It’s also essential to invest in third-party due diligence assessments by recognised service providers, which can be used and trusted by advisers in their own compliance processes when evaluating the P2P platform. “Beyond that, it is of course key to deliver a product that brings value to specific client situations and that’s easy to use for the advice firm – advisers, paraplanners and administrators. “Platforms have made a big effort to provide online portals that offer investment valuations and updates on loan performance.
“With the transparency that P2P offers and the reality that some loans do underperform, platforms have to get the balance right between simple practicality and necessary supporting detail.” Taylor believes the new rules will help advisers scrutinise providers on their risk management, demonstrating what they do to ensure compliance with the rules. P2P property lender Proplend has a dedicated wealth manager portal to help advisers give advice on a loan-by-loan basis where they can also track performance.
But Proplend founder and chief executive Brian Bartaby admits it is still difficult to attract the advisory market. “IFAs are always going to be a hard nut to crack as clients can ultimately access the platforms directly,” he says. “It is difficult for IFAs to sign up to multiple platforms and offer diversification, it just takes too much time.”
However, City & Capital’s Hicks is confident that the regulations will give advisers more confidence in the sector. “Further FCA focus and resulting regulations start to improve understanding, which is the first step to improving the link between IFAs and P2P,” Hicks states. “As these changes bring about improvements in transparency across the industry, this will help advisers to better understand the features, risks and benefits.
“Due to the size of the market, this is an investment opportunity that advisers should be talking to the relevant clients about – even if only to discount it. As trusted advisers – and holding the badge of independence – this is really important. “Clients will also start to ask about P2P more, therefore internal investment in training advisers about the nuances of P2P should be something firms take seriously.”
P2P platforms may have to play the waiting game for now, but there are clearly benefits for all parties – in the form of higher returns for advisers and their clients as well as further distribution for lenders – in being willing to work together.