UK investors have been able to invest directly in peer-to-peer loans for a number of years, but last May saw the launch of the first investment trust focused on peer-to-peer and platform-originated loans, P2P Global Investments (P2P). Also last year, GLI Finance (GLIF) refocused its portfolio away from collateralised loan obligations towards small and medium-sized enterprise (SME) finance platform investments. It is now looking to launch a second fund focused purely on loans to SMEs.
This year, the fledgling peer-to-peer investment trust sector has doubled with the launch of VPC Specialty Lending Investments (VSL), which raised £200m in March 2015, and Ranger Direct Lending (RDL), which recently raised £135m. Ewan Lovett Turner, director of investment companies research at stockbroker Numis Securities, says these trusts potentially have a low correlation to equities and could offer an attractive risk profile.
All four peer-to-peer loan trusts are trading at premiums to their underlying net asset value (NAV). This is not surprising as the trusts target higher dividends and total returns than some existing debt funds.
P2P Global aims for annualised returns of 5-15 per cent and a dividend of 6-8 per cent a year on the issue price, while VPC Speciality Lending aims for a net total return in excess of 10 per cent a year and a net dividend yield of 8 per cent a year. Ranger is targeting dividends that equate to a yield of 10 per cent a year on its issue price.
ABOUT PEER-TO-PEER LENDING
Peer-to-peer lending is the practice of lending money to unrelated individuals, or "peers", without going through a traditional financial intermediary such as a bank or other traditional financial institution. This lending takes place online on peer-to-peer lending companies' websites using various different lending platforms and credit-checking tools.
The sector is rapidly expanding, with a lack of bank lending driving demand both in the US and UK. There is also a need for capital for small businesses as these are under-served by the banks.
These peer-to-peer investment trusts offer exposure to a different type of risk than more established debt funds, which are typically focused on larger issues from governments and corporates. Some of the new trusts' assets may theoretically be less risky as higher-quality consumer loans can have lower default rates than some riskier institutional debt.
Peer-to-peer and platform loans typically have a shorter duration than other listed debt funds. VPC, for example, is targeting a duration of less than two years, which will make it less sensitive to interest rate rises.
The new trusts vary from each other, with P2P Global, VPC and Ranger offering exposure to a mix of small business and consumer loans, while GLI focuses purely on small business loans. GLI also has nearly half of its assets in the equity of the originating platforms rather than their loans. This makes it theoretically higher risk but also potentially higher return because it can also benefit from volume growth. P2P Global will only invest up to 5 per cent of its assets in the equity of platforms, while VPC Speciality will only invest up to 10 per cent.
TRUSTS VERSUS DIRECT LENDING
Buying one of these trusts is very different to investing directly in peer-to-peer lending sites. The trusts offer exposure to a greater number of loans than if you did it yourself, and a wider range of platforms. They may also offer exposure to debt you might not be able to access directly via UK peer-to-peer lenders.
These trusts are geographically diversified as they include platforms in the US, and in some cases Europe, with trusts such as P2P Global and VPC Specialty preparing to expand in Australia.
They have dedicated teams choosing the loans which do extensive due diligence on both the underlying loans and the platforms that originate them. This saves you doing your own research, which has to be quite thorough, and you might not have the resources or access to get all the information they do.
P2P investment trusts will eligible for inclusion in an individual savings account (Isa) from 1 July. There are also plans to allow peer-to-peer loans to be held in individual savings accounts. And from April 2016, however, the first £1,000 of direct peer-to-peer earnings will be tax-free, although the limit is capped at £500 for higher-rate taxpayers.
Shares in UK-listed investment companies can also be held in self-invested personal pensions (Sipp), whereas very few Sipp operators accept direct investments in peer-to-peer loans in their wrappers.
The trusts can also take on debt, known as leverage, to boost their returns by investing more than the assets they have raised. However, this also increases their risk because if assets do not do well the extra exposure increases losses.
However, if you lend yourself you have more transparency in that you choose and see what loans you are invested in.
It is standard for funds to publish their top 10 holdings on their monthly factsheets, and investment trusts often provide a full list of their holdings in their annual reports. But the market-lending-focused trusts do not list individual loans because they have exposure to tens of thousands of small ones via platforms, meaning investors cannot know some or all of the individual holdings.
P2P Global also does not publish the names of all the platforms through which it originates loans, or any of those into which it has put equity, although says it will publish more information as it invests more.
Charges for direct peer-to-peer lending are typically lower relative to debt funds, including the investment trusts focused on this area.
Mr Lovett Turner says that the fees on these trusts are high. "The performance fees are high as is often the case with a new asset class, but these funds need to deliver on their targets to justify them," he says.
P2P and VPC, for example, don't have hurdle rates on their performance fees.
Risks of default
The main risk with the platform lending trusts, as with any debt-focused investments, is default of the underlying holdings. Peer-to-peer lending is a relatively new form of finance. Most of the UK lenders were set up after the financial crisis, meaning they haven't been through many testing times. A deterioration in the economic climate and rising unemployment could lead to an increase in defaults.
This means that the investment trusts don't have much of a track record to assess at fund or asset level, whereas bonds and loans have credit histories going back decades.
However, some of the management companies running these trusts have longer track records than their London-listed trust. Victory Park Capital, for example, the manager of VPC Specialty Lending, has been investing in this area since 2010.
"We do not know what returns we should expect from these investments over a cycle, or what their risk behaviour will be, so assessing the risk/return balance will involve more guess work than it does for, say a mainstream corporate bond fund," says Nick Sketch, senior investment director at Investec Wealth & Investment.
Simon Champ, chief executive officer of Eaglewood Europe, which runs P2P, says the biggest cause of default is increasing unemployment. "We are absolutely focused on the high end of lending so would weather any downturn extremely well," he says. "It might mean our trust is slightly lower yield than some, but we are confident we will still deliver positive returns if unemployment rises."
James Carthew, research director at QuotedData, is concerned that in the US some of the consumer lending platforms' volumes are largely driven by credit card refinancings. "We will need to see how these ones in particular fare through a credit cycle," he says.
It is unclear how these trusts will react when interest rates rise, although the underlying platforms may be able to raise the rates for borrowers. However, defaults could rise, and the yields on the trusts would appear less attractive.
Matthew Hose, equity analyst at Jefferies, is also concerned that too much lender capital could cause spread compression, which would make the returns on these trusts come down.
Note that the P2P investment trusts are listed equities so could move with equity markets regardless of the performance of their underlying debt holdings. If defaults rise in one investment trust affecting its returns, it could affect investor sentiment towards them all.
Returns could also be affected if the trusts do not manage to continue to source enough good loans that pay attractive levels of interest and do not default.
In the UK, the Peer to Peer Finance Association is revising its principles on how it expects lenders to act, and will look to prevent them from allowing institutional lenders to cherry pick loans. However, P2P, GLI and VPC say they will not be affected as they don't cherry pick loans ahead of retail investors.
All four peer-to-peer investment trusts trade at premiums to their net asset value (NAV). P2P Global Investments is on a premium of nearly 13 per cent - one of the highest of all listed debt funds - while VPC Specialty Lending is on more than 4 per cent. Premiums are not unusual among higher-yielding investment trusts, but Mr Lovett Turner says: "It is uncomfortable when you see years' worth of potential returns wrapped up in a premium."
These premiums could come down or move to discounts if the underlying asset class performs badly, one of the platforms underlying a fund fails or default rates are higher than expected. A significant raising of interest rates could cause the premium to fall, although Mick Gilligan, head of research at stockbroker Killik & Co, does not anticipate this.
Mr Hose likes VPC Specialty Lending as its portfolio ramp-up is progressing well - it is more than 70 per cent invested - and can be bought on a lower premium to NAV than P2P. He says VPC's rating "does not yet reflect its dividend yield potential".
Reasons for P2P Global Investments' 13 per cent premium include the fact that it has been running longer, is larger and provides exposure to more mature platforms. Its returns have improved month on month as capital has been deployed and leverage is now being introduced which should enhance returns further. P2P is also on track to meet its dividend target.
However, P2P is seeking shareholder approval to do another C share issue in the next few months. C share issues can allow investors to get into a trust at a different rating to what its ordinary shares trade at, so in this case you might soon be able to get into P2P at a lower premium to NAV.
Mr Gilligan says that as it is too early to see how these trusts have performed, a sensible approach might be to invest a very small amount in each.
Other commentators suggest you stick with listed debt funds with longer track records, and you can see their suggestions in our April article on Alternatives to traditional bond income.
Peer-to-peer/platform lending investment trusts
|Trust||Market cap (£m)||Premium to NAV (%)||Target dividend (%)||Target Return||Base Fee||Performance fee|
|GLI Finance||117||10.1||9.1*||10%-15% a year||2% of gross assets||na|
|P2P Global Investments||219||12.9||6-8||Assets with 5-15% target returns||1% net assets||15%|
|P2P Global Investment C shares||273||10.1||6-8||Assets with 5-15% target returns||1% net assets||15%|
|Ranger Direct Lending||141||5.9||10||Net total return of 12-13% a year||1% net assets||10%|
|VPC Specialty Lending||204||4.2||8||Net total return 10%+ a year||1% net assets||15%|
Source: Numis Securities as at 29 May