As peer-to-peer lending comes under fire from critics, including former FSA chairman Lord Adair Turner, Hardeep Tawakley looks at three P2P trusts and asks the managers about their investment strategies and how they control risk in their portfolios
Less than 18 months after launch, P2P Global Investments (P2PGI), the first peer-to-peer lending investment trust, was already one of the biggest trusts on the London Stock Exchange, having raised over £800m through several fundraisings.
The trust targets an annual 6%-8% dividend yield by investing in over 180,000 loans from 16 carefully selected platforms from a global base of more than 200. Many of the platforms, particularly those based in the US, are not available to individual investors.
The majority – around 60% – of P2PGI's lending book is from US consumer loans, with the rest made up of 17.5% European consumer, 1.7% Australasia consumer, and 11% US and European SME loans. A small amount remains in equities, as well as cash and money market instruments.
Manager Simon Champ refutes the notion peer-to-peer lending trusts are automatically a high-risk option for investors, arguing that P2PGI is a conservative vehicle that focuses on "high-quality loans".
He said: "You do not see specific default levels on categories such as credit cards or personal loans in bank figures, but in P2PGI's loan book there is 100% disclosure.
"I see between 50 and 70 data points for every single borrower; from salary figures and employment history to credit card volatility. This allows us to only invest in those loans that we know will stand up to the type of market conditions seen in 2008 and 2009."
Champ uses the example of a loan at a rate of 9% to a 'high-quality' borrower who has an expected default rate of 0.5%, versus a loan to a 'high-risk' borrower at a higher rate of 19%, with an expected default rate of 9.5%. While both loans should net an 8.5% return overall, the former is more attractive if another financial crisis were to occur.
"If the former borrower is defaulting at triple the normal rate – at 200bps instead of 50bps – the loan is still viable, just at a lower rate. But the latter borrower, at a triple default rate will be in trouble," he said.
Although the vehicle has the ability to use leverage – limited to 150% of NAV – to enhance returns, Champ said he does not aim for a "highly leveraged boom and bust strategy".
The vehicle is currently leveraged at 69% of NAV.
"We will always favour using less leverage for returns because that also means lower volatility, which is what investors want."
For such active management, the vehicle charges a 1% annual management fee plus a 15% performance fee of the 'adjusted net asset value'. Champ argues this is needed as an investor should want the manager to be incentivised to create attractive returns.
We will always favour using less leverage for returns because that also means lower volatility, which is what investors want.
Meanwhile, Ranger Direct Lending charges investors a 10% performance fee, alongside a 1% annual management charge.
However, US-run Ranger does differ from P2PGI in several ways. The trust raised £135m last year and invests in loans that have been originated or issued by a variety of 'direct lenders', rather than peer-to-peer lenders. This allows the fund to target a higher annual dividend yield of 10%, rather than the 6%-8% offered by other P2P trusts.
"Direct lenders for the most part have been around for much longer than peer-to-peer lenders. Many of these organisations are experienced companies with proven underwriting models that have been successful through the financial crisis," said Bill Kassul, partner in the Ranger Direct Lending fund.
Around 75% of the fund's loan portfolio consists of secured loans, however, and these are backed by commercial assets and/or borrower personal guarantees. The average loan duration is below two years.
We have designed a fund that is, in effect, a quasi-ETF. Other peer-to-peer lending trusts are all actively-managed, with different leverage limits to enhance returns.
Funding Circle is one of the UK's largest peer-to-peer loan platforms, and is the first to launch a trust focusing on the loans it originates.
The Funding Circle SME Income fund was listed on the London Stock Exchange in November 2015 and raised £150m at launch. It is targeting a dividend yield of between 6%-7% per annum.
The trust allows access to loans to small businesses, rather than consumer loans, with the vehicle also able to make loans to SMEs. A minimum of 50% of the loans in which it invests must have originated in the UK, versus a maximum of 50% for the US.
Sachin Patel, head of UK capital markets, refers to the trust as a passive – rather than active – product, as it invests in loans almost exclusively via Funding Circle's UK and US platforms.
The vehicle is also far less levered than other P2P vehicles, and can only apply leverage of up to 0.25 times the current NAV.
"The assets we originate are very vanilla. We make the same loans that banks make and to the same customers they have lent to for decades," explained Patel.
"We have designed a fund that is, in effect, a quasi-ETF. Other peer-to-peer lending trusts are all actively-managed, with different leverage limits to enhance returns.
"They have a lot more discretion on which platforms to invest in, and charge higher fees. But our product is very much passive beta access to SME loans via our platform. It is the least sexy and most predictable fund in the peer group."
Transparency is high on the group's agenda and it publishes every loan that comes to the marketplace via the Funding Circle platform. This allows investors in the trust to have confidence they know what they are buying, according to the manager.
Due to this passive investment approach, Funding Circle's vehicle has no additional fees beyond the cost of running the trust, which is unusual in the P2P trust sector.
"We charge one fee, which is the platform fee and then the cost of buying the vehicle on top. We are talking about 10 basis points rather than anything more than 1%. There is no annual management fee or performance fee," Patel added.
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