Peer-to-peer lending has moved mainstream, with many platforms now offering investors the opportunity to invest tax-free through their ISAs. However, listed investment vehicles could offer better returns.
Peer-to-peer lending: do listed investment trusts offer the best returns?
How does peer-to-peer work?
Pared down to the basics, peer-to-peer (P2P) lending is very simple: it matches individuals or companies that want to borrow money with people who want to lend it. P2P is attractive from the borrower’s perspective as it can be very quick to get a loan, and often it can be cheaper than doing so from a bank. From the lender’s perspective, you can achieve a better return than money in a bank account and it can offer diversification from investing in stocks and bonds.
In exchange for a fee, a P2P platform will do due diligence on the borrower to see how creditworthy they are, and it may also, though not always, reduce the lender’s risk by making many small loans to different borrowers. Therefore, if one borrower defaults, the financial impact on the lender may be more modest. This is effectively a reduction in the annual rate of return.
Some platforms include fees and an allowance for defaults in the headline rate they offer, while others may have a slightly higher prospective return, but this could be stated before costs.
The best known P2P platforms include Zopa (which until recently was closed to new deposits), RateSetter and Funding Circle, but there are around one hundred operating in the UK market.1
Lenders on P2P platforms face several different types of risk, not all of which can be avoided:
- Rise in defaults
Defaults will erode the return you receive, and could even mean you make an overall loss. The UK is in a very benign economic environment at the moment; employment is at an all-time high and defaults are low. Defaults will pick up when the economy weakens, but no one knows what the impact will be until this happens.
- P2P platform credit checks are not sufficiently robust, causing lenders to misallocate their capital
P2P platforms do their best to check the creditworthiness of their borrowers, but just as the financial crisis of 2008/09 saw, AAA rated paper downgraded to junk, they may not always get it right. The pressure to hit sales targets could lead to loosening of a platform’s credit checking process.
- The P2P platform goes out of business
Platforms should segregate client money from their own, meaning that you don’t face a risk yourself, but you can be quite certain that if they did fall into administration the client service you would hope for would be very limited.
At the most serious end of the scale, it is possible that the platform may not have adequate client money processes in place. The most high profile example of this was TrustBuddy which was listed on the Swedish stock exchange and went bankrupt in 2015, taking with it a chunk of the investors' money.
Unlike banks and financial services businesses, P2P lenders are not covered by the Financial Services Compensation Scheme (FCSS) limit of £85,000 in the UK.
- Accessing your money
Some platforms allow you to access your money for a fee, but others have minimum investment periods which could be several months or even several years long. Lenders wanting to get their money back earlier usually have to pay a penalty fee which can erode a large proportion of the investment return.
UK-listed investment trusts are an alternative
Among the broad range of specialist income funds listed on the London Stock Exchange (LSE) are several that focus on P2P lending.
The UK-listed funds investing in this space have had mixed performance since their respective launches, which helps to highlight that investing in P2P lending is not by any means a risk-free activity. Defaults on P2P platforms in the US have been higher than many expected, and this has impacted their returns.
You can see in the table below that some of them trade significantly below their published net asset value, having failed (so far) to achieve their stated investment goals. However if their performance begins to improve, investors could benefit from both a high income and share price appreciation if the discounts begin to narrow.
With all investments, you should take some time to do your own research and these are no different. Investment trusts are able to use borrowing to enhance their yields and returns, which can work both for and against you.
Some of the vehicles listed below only invest in loans originated on P2P platforms (e.g. Funding Circle SME Income Fund) and therefore offer the purest exposure to the asset class. Others may take stakes in the lending platforms themselves or have balance sheet loans which offer slightly better protection in the case of defaults.
UK listed peer-to-peer lending Investment Trusts
Market Cap (GBP m)
Discount/ Premium to NAV
|Funding Circle SME Income Fund Limited||
|Honeycomb Investment Trust||HONY||GBP||356.9||7.6%||20.4%|
|Hadrian's Wall Secured Investments||HWSL||GBP||85.2||2.5%||9.2%|
|P2P Global Investments||P2P||GBP||652.6||5.7%||-11.5%|
|Ranger Direct Lending||RDL||GBP||
|SQN Secured Income||SSIF||GBP||50.8||7.2%||-1.7%|
|VPC Speciality Lending Investments||VSL||GBP||291.5||7.9%||-11.0%|