P2P lending trusts look to overcome negative headlines

However, investor access has not always been easy. Many have come unstuck in trying to find the right platform – which link lenders to borrowers – to invest with. The sector has also had its fair share of negative headlines. However, investors do now have a range of specialist investment trusts to invest in, some of which offer a curated selection of loans or help circumvent the trickier decision-making associated with selecting a P2P platform by investing in several of them, boosting diversification.

The P2P investment trust sector is still small and remains in its infancy compared with more mainstream sectors, with just a handful of trusts launched to date. But these trusts have attracted investment. P2P Global Investments (P2P), for example, is now over £700m in size, while Honeycomb Investment Trust (HONY) has secured the backing of high-profile fund managers Mark Barnett of Invesco Perpetual and Neil Woodford of Woodford Investment Management.

Some higher-profile trusts have seen their share prices move to premiums to net asset value (NAV) and the appeal is clear: they should offer a higher, inflation-adjusted income stream, diversification from volatile stock and bond markets, and exposure to a growing sector. They also offer some protection from rising interest rates. P2P loans are often short-term, which means new loans would be set at higher rates should interest rates rise. Yet for some investors the theory has been better than the practice.

For example, Funding Circle SME Income Fund (FCIF), the first to launch and now £327m in size, was criticised by brokerage Canaccord Genuity only last week for its weakening returns and was moved to a sell rating – something that could set alarm bells ringing for the sector as a whole. Analyst Alan Brierley at Canaccord Genuity says: “The collapse in returns in the current financial year is alarming. The key driver has been a significant spike in impairments... This performance against a relatively benign backdrop begs the obvious question of what would happen in a recessionary environment."

P2P Global Investments has also had a tough run, with the trust’s share price down 5.8 per cent over three years. It saw investment failures on its underlying portfolio and was forced to write down a £5.5m equity investment in supply-chain financing company URICA, while propping up its own dividend by dipping into its income reserve.

The Ranger Direct Lending Fund (RDL), which specialises in US assets, has also had problems. It was hit by the bankruptcy of Argent Credit, a consumer loan website in Chicago, and has then seen other investments in P2P platforms go bad. After failed attempts to secure a buyer for its assets, the trust now appears to be winding down, with a managed exit by 2019.

That said, there are also success stories. Pollen Street Capital-managed Honeycomb IT has shown a steady return since its launch in 2015. As P2P investors might hope, it has proved resilient during the recent market rout, and has provided a 2.9 per cent total return so far in 2018. Its underlying lending practices and due diligence have proved effective. However, given its position as a shining star in a sometimes difficult sector, Honeycomb's share price premium to NAV is currently at 10.5 per cent.

Opportunities and costs

Despite the concerns over some of the vehicles, there is undoubtedly a structural opportunity in the sector, according to Nick Greenwood, manager of Miton Global Opportunities (MIGO), an investment trust that invests in other trusts. He says: “It is quite a new world, but in theory lending to UK small and medium-sized enterprises (SMEs) should be a fertile area. In the UK, the banks are withdrawing from this type of lending, creating space for alternative lenders. However, it doesn’t seem to be working as well in practice.”

Mr Greenwood says investors have fallen victim to idiosyncratic problems atindividual investment trusts. For example, investors in Funding Circle Holdings (FCH), another P2P investment trust, lost out due to significant costs. The company suffered due to the cost of hedging the dollar back into sterling, and due to the cost of the trust's own borrowing, which is used to provide more in loans than it had received from shareholders to boost returns. So the underlying portfolio of loans may have been yielding 10 per cent, but much was lost before it got to shareholders.

There is also the problem of P2P being used as a catch-all term. Mr Greenwood says relatively few of the trusts fit the true P2P description and each trust offers a different investment profile, making it difficult for investors to be fully sure of what they are buying.

Pablo Beivide Cavia, a director at Axis Corporate, a consulting firm, agrees. He says the reality is that there is no one type of P2P loan that investors can or should get exposure to.

"Not all loans are created equal," he says. "Consumer credit and SME working capital loans have very different risk profiles to something like [traditional] property-based lending. The former offer more predictable default rates, a steady repayment of capital, and much greater potential diversification with little or no cyclical concerns. The latter involves assets that are very illiquid, are not repaid until the asset is sold or refinanced and are hugely subject to cyclical fluctuations in land prices."

There are also more fundamental differences between some of the trusts that investors should be aware of, despite them all being labelled P2P. Some collect investors' capital and provide loans directly to those who need them, therefore acting as a platform for borrowers and lenders to meet. Other trusts invest directly in other platforms, leaving the decision of who to lend to others but conduct due diligence on which platform is the best and managing the risk of lending. Some trusts do both. There are also different types of platforms, all of which have varying levels of involvement in investors' capital and who it gets loaned to.

According to Mr Greenwood, investing directly in a platform, where the trust's managers are making lending decisions, is a far more volatile prospect. Those that win may generate significant returns, but this is an increasingly crowded sector and there will be failures and consolidation. “It is all early days and not all will carry on," he adds.

Economics and regulation

As Mr Brierley pointed out in his criticism of FCIF, potentially the biggest risk to the sector is its durability during an economic downturn. Due to the nascent nature of the asset class, this is as yet untested.

“The biggest consideration with all of these trusts is that their asset bases have not been tested through a cycle," says William Heathcoat Amory, founder of research company Kepler Trust Intelligence. "While that does not necessarily mean they will definitely struggle in a market downturn, it does mean that no one knows how they will perform. Naturally, this does make them a risky proposition."

There are further risks, which investors will find difficult to price into the value of the investment. Earlier this year, the city watchdog, the Financial Conduct Authority (FCA), announced plans to limit who can invest directly with P2P platforms and how much they can put in, due to the significant risks involved. While this won't directly affect investment trusts that buy into the sector as a whole, it could affect the popularity of the asset class, which could weaken returns. But Mr Beivide Cavia says regulation remains as much a risk as an opportunity.

“The regulation of this burgeoning sector has come under scrutiny and from the outset P2P platforms in the UK have sought regulatory guidance from the FCA," he says.

However, he says that the FCA's planned rule changes, which could come into force next year, recognise the increased complexity of some business models and will formalise a regulatory regime to govern the industry for the next decade at least. This may add costs but could bring some additional discipline and reduce the risks to investors.

Fund performance

Source: FE Analytics as at 26/11/2018, *Association of Investment Companies, **Includes performance fee