Why peer-to-peer lending can be more than just about great returns
Roxana Mohammadian-Molina argues that peer-to-peer lending (P2P) is a tool that, if used appropriately and securely, can help investors diversify their portfolios and enhance their targeted returns.
Let’s tackle the elephant in the room: P2P lending has had a bumpy year; while some platforms did very well and delivered great returns to lenders, some others had negative press and unfortunately had to close.
The main difference between the two groups was chiefly around how P2P platforms saw themselves: the latter tended to see themselves as an ‘ebay for loans’ and focused on marketing, while the former tended to focus on the due diligence on the loans they listed.
The year ended with the FCA introducing new regulations to enhance the protection of retail investors. Yet, Roxana argues why P2P lending is a tool that, in some cases, can be a great asset into your portfolio. She believes P2P lending, once again emphasizing, ‘in some cases’, can help diversify a balanced portfolio, enhance returns, optimise a portfolio’s risk/reward profile as well as, help investors support causes they may care about such as helping local housebuilders build the affordable homes the country needs.
Portfolio diversification through P2P lending
Let’s start with how P2P lending can help portfolio diversification. Generally, diversification is the risk management strategy of combining a variety of assets to reduce the overall risk of an investment portfolio. In the context of P2P lending, diversification is achieved by spreading the risk of ones portfolio, i.e. by constructing a portfolio of several loans each with a different risk/reward profile.
Some platforms, such as Blend Network, have an AutoLend feature built-in where investors can select the criteria that best represents their own risk/reward profile and spread their available funds across several loans according to their personal risk/reward profile. For example, one may say ‘I only want to lend on loans that have 10‐12% return p.a. and I don’t want to lend any longer than 18‐months’. One would then select those criteria and lend automatically based on those criteria.
Diversification is also achieved by enabling investors to spread their available funds, based upon their own criteria. In this manner, investors are in fact constructing their own diversified portfolio with the return that they select and the maturity that they select based on their very own risk/return profile.
Enhanced returns through P2P lending
The UK Marketplace Lending Index (Figure 1) which measures the returns available from tech enabled lending in the UK shows that over the past decade, the average return offered by UK P2P lending platforms has hovered between 5.0-7.5% p.a. on an annualised basis. Some platforms such as Blend Network offer even higher returns, between 8.0-12% p.a.
Figure 1: UK Marketplace Lending Index
Yet what is important to note is that in P2P lending, higher returns are not necessarily associated with higher risk.
Why? Because often higher returns are achieved due to the opportunistic nature of the loans, rather than the risk. For example, Blend Network focuses on lending to experienced property developers across the UK regions who struggle to access funding because their housing schemes, and therefore their loan size, are small for most lenders.
Blend Network lends between £150,000 and £3,000,000 which is a relatively small loan size, a niche market where there are not many active lenders. Therefore, Blend Network is able to achieve 8.0-12% return p.a. for its lenders who can lend any amount from a minimum of £1,000 per loan.
P2P property lending as a force for good
The UK’s housing shortage has been described by successive governments as the nation’s most urgent and complex challenge and solving it as “the biggest domestic policy challenge of our generation”.
A commonly cited figure in current debate puts at 300,000 the number of houses that need to be built annually by the mid-2020s – 100,000 of which need to be affordable. Yet according to NHBC data, only 160,470 homes were built in England in 2017/18 (Figure 2).
Figure 2: Homes needed vs homes built
With public finances under extreme pressure, lack of funding for small and medium property developers certainly constitutes a challenge in achieving such targets. Indeed, according to the Home Builders Federation, availability and terms of financing for residential development has become extremely difficult for small housebuilding companies over the past decade or so.
Lenders have drastically changed their attitudes to the sector since the Global Financial Crisis. As a result, we have seen a dramatic decline in the number of SME property developers. According to the same report by the Home Builders Federation, in 1988 small builders were responsible for 4 in 10 new build homes compared with just 12% today.
I passionately believe that the only way we can face and tackle the housing crisis is by allowing private investors to be part of the solution by lending cash to those experienced property developers who are building the homes the country needs.
This is exactly what P2P platforms such as Blend Network do by connecting lenders with cash and looking for yield to experienced property developers looking for funding. And I strongly believe that the only way to build trust in P2P platforms is by maintaining a high level of due diligence on the loans and by ensuring that platforms are not turned into an ‘ebay for loans’. Instead, I strongly believe that platforms’ main job is to perform a high level of enhanced due diligence and ensures that it builds a track record.
Your capital is at risk if you lend to businesses. P2P lending is not covered by the Financial Services Compensation Scheme. Investments are illiquid (the inability to sell assets quickly or without substantial loss in value). Past performance is not a reliable indicator of future results.