Every month in FundWatch we’ll look at a specialist fund that offers investors a collective way to invest in the alternative finance sector – this month we kick off with the first and still the biggest fund in this fast evolving space.
P2P Global Investments, managed by specialist asset managers Eaglewood is a closed end fund listed on the London stock market with a ticker of P2P and is very easily acquired through an online stockbroker service and can be included in an ISA or SIPP.
Details of Fund
Ticker: P2P Yield: 5.3%
Last share price: £11.35
Premium / Discount: 15.9% Market cap: £228m
Average bid offer spread: 1.3% Dividend Frequency: Quarterly
Last NAV per share: £100 Domicile: UK
Launch Date: May 2014 Managers: Steven Lee, Jonathon Barlow, Simon Champ
Top shareholders: 8.5% INVESCO Asset Management Limited, 7.8% Ruffer LLP, 7.5% Thesis Asset Management plc., 7.5% JOHCM UK Equity Income Fund, 7.4% AXA Investment Managers Paris
Investing in financial disruption
P2PGI is the first of wave of new stock market collective investment funds that are designed to give investor’s an easy way to invest in the fast growing P2P lending space – also called market place lending. These diversified funds have emerged because of a unique structural change in the basis of modern finance after 2008/9. The global financial crisis revealed a scary fact, namely that vast high street banks were much riskier than we first thought. These huge institutions may have been wholesaling vast amounts of money, but they were also wholesaling vast amounts of risk. Government’s may have offered to back stop the deposits placed in these systemically important institutions but many investor’s started to worry about the potential for loss of capital.
This crisis in confidence directly led to a financial crisis which has in turn resulted in a global set of monetary policies built around historically low interest rates. Put simply central banks need to keep interest rates low in order to help stimulate economic growth.
But these low interest rates have in effect financially repressed savers in bank savings accounts – some bank deposit accounts pay next to zero in terms of interest rates. In the past this dire situation for savers would have been the end of the matter – we’d simply have to put up with these low rates. But the crisis in the banking system opened opportunities for new, online platforms to emerge within the alternative finance space – many of them determined to offer higher rates of return for investors.
Investors can now put their money to work on these lending platforms – known as market place lenders or P2P platforms – and generate an income way in excess of the rates on offer from high street banks. Market leading names include Zopa, Ratesetter and Funding Circle here in the UK and Lending Club and Prosper in the US.
But deploying your capital on these platforms comes with its own hassles. You have to know the structure of the platform, how it lends, and understand who you are loaning money out to.
You also need to diversify between different platforms and borrowers to generate a strong enough income to able to withstand any possible future defaults by the borrowers to whom you’ve lent money.
In reality the best way of doing this is via a fund which does all the hard work for you and then levies a management fee for its services – luckily this alternative finance space has now grown to such a scale in the UK and the US that funds can emerge to help invest in a diversified series of platforms.
The first and still the biggest fund to emerge out of this huge structural change is called P2P Global Investments – with the P2P representing peer to peer. The fund is managed by a company in part owned by hedge fund Marshall Wace which has been a big player in the market place lending/P2P space, alongside the fund’s UK principal Simon Champ (formerly from Liberum).
The business model behind P2PGI is actually very simple. It originally raised just shy of £200m to invest in a range of loans in market leading platforms such as Funding Circle, Zopa, and Ratesetter in the UK as well as Prosper and Lending Club in the US – it’s subsequently raised additional sums to beef up its scale and reach.
The loans on the funds’ book range from a few months (platforms that lend to businesses such as Market Invoice tend to advance loans for anything between 30 and 90 days) to five years (many consumer loans are at this duration).
The underlying borrowers also vary between consumers (Prosper, Lending Club, Zopa and Ratesetter) through to small and medium sized businesses (Funding Circle and the growing army of SME lenders in the US).
In reality P2PGI is a big collection of thousands of bits of different loans to lots and lots of different borrowers producing an income yield based on the interest paid. The trick to making this a successful fund is to balance the following factors:
· The risk of default by the borrowers. This ‘loss rate’ will vary over time (worse during a recession), between lenders and platforms, and over different durations. Losses on consumer loans range between 1 and 5% per annum while SME loans can sometimes produce twice as many defaults as this level.
· The need to keep re investing the cash. Many of the loans that P2PGi buys into are fairly short term (1 to 3 years) with the borrowers continuously paying back on a month by month basis. All that cash needs to be reinvested by the fund to keep up the income payout.
· The credit spread. Put simply, low risk borrowers like prime consumers pay out a smaller interest rate than risky small businesses. This is in part a question of defaults but also a function of the state of the market i.e. consumer loans are very mainstream whereas small business lending is still fairly small scale and immature. That credit spread means that underling loan yields can vary between say 4 to 7% for consumers through to 6 to 15% for small businesses
· The fund can also use gearing to increase the yield on offer from the platforms. Like many of its peers in the investment trust sector, it can borrow money cheaply as an institution and then reinvest this cash in P2P loans, at rates that are hopefully much higher than the cost of capital
· Generate some potential for a capital uplift. The vast majority of the money raised in the stock market listing of P2PGI was used to fund loans that in turn generate an income. The fund is targeting an overall income return of 6% to 8% per annum but a small amount of this capital may also be used to invest in the equity of the underlying platforms. The idea here is simple. Many platforms are desperate for lenders like P2PGI to put their millions to work providing capital for borrowers. In return for this money P2PGI may be able to also access the equity in the platform – helped along perhaps by a small seed investment in the right platform. As the platform grows in size, the value of that equity might multiply – the leading US platform called Lending Club is now listed on the US stock market and is worth a massive $9 billion. Even say a tiny 0.1% equity stake in this fast growing business would have been worth $9 million on its own! P2PGI hopes to be able to line up a number of small equity investments which might provide the funds investors with some capital uplift.
Our bottom line? We’d guess that P2PGI is very much on target to hit that 6 and 8% per annum target return, possibly with the final return closer to the 8% level by 2016. That’s a decent number and helps explain why the fund now trades at a chunky premium to its underlying net asset value – which arguably makes it a bit more expensive than some of its rivals, and also helps to depress the potential long term income return.
It’s also fair to say that there are some very obvious risks with the marketplace lending/P2P loans model on which this fund is based. Banks exist for a very good reason, which is that firstly they can be bailed out by governments and secondly because they house a huge infrastructure of risk management.
When our economy starts to slow down again, we should expect the big banks to announce another swathe of bad debts – with the central banks probably riding to the rescue again. P2P loans platforms don’t have any government guarantee (they’re not even FSCS protected) and although they do offer some due diligence based around borrower risk, this is likely to be fairly primitive compared to the risk models built by the banks.
The key concern has to be that defaults will rise in a recession and that planned 6 to 8% return starts to fall as losses accumulate. The fund manager is using its own in house credit models to minimise the risk – it looks at every borrower it lends to and assesses their risk – and hopefully any future losses won’t be too high. But the risk is obvious. There is also a concern about liquidity and platform risk i.e what happens if a platform goes bust and the fund needs to sell its loans quickly? There are secondary markets for many of the big platforms but they’re still fairly limited in scale. That means that the fund could be hit if investors start demanding their money back and it has to liquidate its loan book quickly.
Although we think these default risks are real, the rate of return is probably enough for many investors to warrant an investment over the long term. We’d guess that a long term return of 8% per annum is possible and we think the fund’s shares might even trade higher as investors scramble to get on board – especially the more recently issued C class shares, where the capital raised is steadily being deployed on to platforms.
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