We now have all the final details on the new ‘Innovative Finance’ ISA (I covered the details last week – here), allowing investors to hold peer-to-peer loans in a tax-free ISA wrapper.
The new ISA will draw many new investors to this space but advisers may not feel as prepared. Due diligence and lack of knowledge about this sector prevents many from being able to provide clients with appropriate advice.
Due diligence for a peer-to-peer investment might consist of at the minimum; a review of the loan specifics, liquidity provisions, security, parties (who is operating and managing the platform), continuity, compliance and taxation – and that’s just on the platform, there is still the individual loans to consider.
Direct peer-to-peer investments through an ISA may be too difficult for advisers at the moment and we still have to wait till 6th April, 2016 to access them, but there are a number of closed ended funds listed on the London Stock Exchange that have been ISA eligible since 1st, July 2015 that invest in peer-to-peer lending. This structure may feel more familiar to advisers and enable them to benefit from the expertise of the fund managers to pick and choose suitable platforms and investments.
Institutions have had a growing interest in this sector due to the higher yields, lower volatility and predictable returns. Some innovative companies have come up with a way for investors to benefit from their expertise and resources to instantly access a well-diversified portfolio of loans across several platforms.
There are several investment firms that have emerged to take advantage of the peer-to-peer lending sector. Three of these early-adapters are GLI Finance, Victory Park Capital and Ranger Capital Group
The reluctance of banks to lend to small and medium enterprises has led GLI Finance (GLIF.L) to become a leader in the alternative finance sector. Their business model revolves around making equity investments in funding platforms, as well as investing into the debt they originate.
To date GLI Finance has invested in 19 platforms, all focused on small and medium enterprises, in 3 continents. They attempt to minimize their investee companies chance of failure by maintaining an active and close relationship with each strategic partner. The actively advise the companies on activities such as sales and marketing to ensure the investment becomes profitable.
Victory Park Capital’s Speciality Lending Investments (VSL.L) floated on the London Stock Exchange in March 2015, raising £200 million. The fund’s investment strategy revolves around investing directly in both the debt originated by the platforms as well as the equity of the platforms themselves. Owning shares of the platform stake could prove to be hugely valuable in the long run, illustrated by the IPO of Lending Club – the big US peer-to-peer lender was valued at $5.4 billion in 2014.
Ranger Capital Group is a US investment manager that launched a specialist fund to invest in loans that originated in peer-to-peer lending platforms (primarily Prosper and Lending Club in the US). Ranger Capital Group’s Ranger Direct Lending Fund (RDL) raised a hefty £135 million on the London Stock Exchange in May.
Ranger Capital Group states they intend to outperform traditional benchmarks through the use of an application programme interface (API) provided by the lending platforms to access loan data followed by an algorithm to invest in those loans that align with their investment objective.
Considerations
Investors must be aware of the nature of their exposure if they decide to invest in closed end funds. Conventional peer-to-peer lending investors have direct exposure to the underlying loans. If a loan goes badly, the investor still has a chance to recover their funds from the underlying assets (if it’s secured).
By investing in a closed end fund, investors are not entitled to anything if the fund were to perform badly. The flip side is these funds are managed by professionals who have far more resources than the average investor.
The expertise that professionally management entails does come with a cost: management fees, distribution fees, etc. Investors have to decide whether the benefits from professionally managed funds and the diversification they bring outweigh the costs of management and the chance of the fund performing poorly.