We present the top industry tips for making the most out of your peer-to-peer investments. Michael Lloyd reports…
Inflation has reached a 30-year high, piling pressure on savers and leading many to take on more risk in the search for yield.
Even the Financial Conduct Authority (FCA) is actively encouraging savers to move money out of their stagnant bank accounts and to invest their funds instead. But the stock market is still filled with volatility and investors are understandably nervous about the possibility of losing money by making a bad equity bet.
If only there was an investment solution that offered inflation-beating returns at a relatively steady rate, with minimal risk of losses.
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Peer-to-peer lending has been around for more than 16 years and aims to cut out the middleman by allowing investors to lend directly to borrowers, or to a range of borrowers via a P2P platform. The borrower pays interest monthly, and the platform takes a small share of this interest while investors keep the rest.
This is similar to the structure of a traditional bank, except banks take a much larger share of the borrower fee, due to the higher costs associated with running a banking business.
The main risk in P2P lending is that the borrower will not be able to repay their loan in full or in a timely manner. However, the average default rate across the entire P2P sector since inception has remained relatively stable at around two per cent. And there are a few ways to reduce this risk through P2P lending.
Before investing in P2P, it is important to have basic knowledge of the sector, how platforms operate and what sort of things an investor should look out for.
P2P platforms are regulated by the FCA, and prior to investing in a P2P platform, investors should check that their lender of choice is on the City watchdog’s register of regulated financial services businesses.
Some P2P firms may appear under their business name, rather than their trading name – for instance, JustUs may appear under its official business name of eMoneyHub.
If you are looking at opening an Innovative Finance ISA (IFISA), check HMRC’s list of approved ISA managers to ensure that your platform of choice has been authorised to offer the tax-free wrapper on its investor accounts.
Filip Karadaghi, co-founder and managing director of property lending platform LandlordInvest, says that regulated, directly authorised platforms have a “badge of honour” after passing through the regulator’s due diligence.
“Once a platform becomes authorised, they’ve gone through a process where the regulator reviews all aspects of the business, from its technology, scale of team and brand,” he says.
“It took us two years to go through the application and the FCA asked us every possible question and more.”
Once you have confirmed that your platform of choice is properly regulated, it is time to do your own research.
New investors should seek platforms with transparent data showing a good lending record with low rates of bad debt, as well as attractive yields which are approximately in line with the borrower rates on offer.
“Do not invest in something you do not understand,” says Karadaghi.
“You should treat it exactly the same as making any major purchase in your private life, like buying a car, and I feel some investors are missing that point.”
Ian Anderson, chief operating officer of ArchOver, highlights that investors should do their own research, diversify their investments and speak to platforms to ask any questions they have.
“Do your homework, do your research, spread your risk across multiple asset types and lastly pick up the phone and speak to the platform,” he adds.
Most platforms will include an office number or customer service line on their website, while other platforms have a chat box function which allows prospective investors to ask questions online. It is also possible to source third party information by reading TrustPilot reviews or accessing expert analysis from sites such as 4thWay.
4thWay reviews platforms for investors and can thus provide a good source of information when they conduct their own research. Managing director and head of research Neil Faulkner says that investors should primarily look for extreme transparency with lots of data, information about lending processes, bad debt recoveries and the people behind the platform.
“You want to be sure that bad debts are not being hidden by extending or refinancing loans, and that the people behind the platforms genuinely have the specific skills and experience they should have for the kinds of loans they are doing,” he says.
“You need to lend where you can spread your money over a large number of loans and you need to lend where the borrowers are typically going to repay in the timeframe where you will want your money back, because early exit options are not always going to be available, even at the very best platforms.
“You need to feel that you truly understand the loans you’re lending in and the profile of those loans, such as the proportion of them that turn bad, how long recoveries take and how much is typically recovered, so that you can decide whether you’re comfortable with that.
“In deciding where to invest, you should be looking at a variety of different accounts and different types of lending, to spread your risks widely.”
Investors are also recommended to look at the underlying nature of the loan and whether there is an asset being offered as security against a default. This means that if the borrower cannot meet their repayments, the P2P platform can take charge of the asset and sell it off to repay investors.
“Make sure you understand the nature of the underlying asset and that the asset is familiar,” a spokesperson from Invest & Fund says.
“Make sure the underlying asset type is long established and the sector very large – so that there is a clear picture of how it performs over a long period and against large volumes.”
The majority of P2P platforms and stakeholders agree that track record is a vital component that investors should research. Lenders can find statistics and information on platforms’ loanbooks on their websites.
Lee Birkett, chief executive of JustUs, says that although it does not indicate future performance, track record is important and financial advisers only point investors towards lenders that have been trading for five or more years. He also adds that during the current economic climate investors should seek asset-backed lending over unsecured lending.
“Track record of consistent positive returns is key,” he says. “If there’s no track record, you’re putting your money on a roulette wheel.
“And ideally, I would suggest asset-backed lending, as unsecured lending has been found out particularly in the current stormy financial waters.
“Any firm operating today that came through the crisis and the evolving FCA scrutiny and due diligence process is pretty sound.”
As well as seeking a track record of the loanbook, platforms and industry stakeholders suggest investors should also research the track record of P2P lenders’ management teams.
They should look for highly adaptable management teams, with multi-sector experience and strong financial and operational controls in place. The key decision maker in the lending team, such as the head of credit or head of risk, should have plenty of experience related to the specific types of loans the platform is offering.
Stuart Law, chief executive of Assetz Capital, says that governance is extremely important and warns that some platforms are only run by one or two directors or have one majority shareholder controlling the business.
“The two main reasons platforms fail is lack of experience in lending and credit and lack of governance,” he says.
“One of the biggest common factors with P2P platforms failing is they are run by one person or one person and their wife or school friend.”
Lenders should look at platform websites to find information on the management team and the platform’s track record, as well as statistics on their average and target returns and their default rates.
“The headline rate of return and even the actual return should not be looked at in isolation, it is much more appropriate to look more broadly at how the underlying P2P investment performs as a distinct asset class and the characteristic of the assets,” says a spokesperson from Invest & Fund.
“Do not be seduced by the interest rate… if it’s very high, there will be a reason for it!”
Similarly, Nicola Horlick, chief executive of Money&Co, says that investors should seek as low a default rate as possible and reasonable rates of interest while being aware of excessive returns.
“They should be suspicious of very high rates of interest,” she says.
“Investors need to look at the statistics page on each site and take account of bad debts. They should not be lured by excessive returns as it is likely that too much risk is being taken.”
Some industry stakeholders go one step further and suggest investors should be wary of platforms that offer cashback deals in an attempt to recruit more sign-ups.
Assetz Capital’s Law says investors should be careful as it implies the platform “does not have enough investors” and the margins do not add up.
“I’d be a bit careful,” he says. “Giving everyone cashback puts the platform in danger of not making enough money to stay in business because the margins are quite thin.”
The FCA appears to have similar concerns. Last month, it outlined plans to ban investor incentives within promotions for high-risk investments.
Ultimately, all that stands between a P2P novice and their first P2P investment is a few clicks of the mouse. But before rushing into a new asset class, investors should do plenty of research and only invest when they are completely comfortable.
Luckily, P2P platforms make it easy to check their track record and regulatory status, and most brands are committed to educating their investors on the risk and rewards that they can expect.
A little bit of time, a little bit of effort and a willingness to take on a little bit of risk could help investors beat inflation and make their money work harder.