Octopus Investments – the UK fund manager with more than £6bn under management – launched a new peer-to-peer lending product in April called Octopus Choice. The new platform has been tailor-made for financial advisers from the outset, a group of gatekeepers that the wider peer-to-peer lending sector has yet to seduce. Octopus Investments has been around for some 15 years and boasts over 50,000 clients. Its raison d’être is to simplify complex investment products for both advisers and individual customers, with a particular focus on tax efficient investments. So why, after 15 years, has Octopus now opted to move into the new-fangled business of peer-to-peer lending? I caught up with Head of Octopus Choice Richard Wazacz and Marketing Manager Stuart Sheppard to find out.
“Over the last couple of years, we’ve consciously been looking at how to create products that are more universal, that have more appeal to a wider customer base,” began Richard, acknowledging that tax efficient investments occupy something of a niche position in the market. The P2P sector stood out as an area in which Octopus would be able to effectively leverage its existing strengths, namely: a loyal following of over 3,500 financial advisers, and “really strong proprietary deal flow”. The latter of these refers to the deal flow of bridging and buy-to-let lender Dragonfly Finance – one of Octopus’ asset backed lending businesses. Dragonfly has been around for 8 years, and has just topped the £2bn mark in cumulative lending – with a loss rate of around 0.1% to date.
The enabling technology and bespoke regulation that goes along with peer-to-peer lending have created an opening for Octopus. “What we realised is that there’s an opportunity to help financial advisers add value to their clients’ portfolios through the P2P market and give retail investors the chance to invest directly in Dragonfly loans,” said Richard. The type of investor he envisages is one who is looking for lower volatility returns than can be found on the stock market, but also for better returns than are offered by cash products. Asset backed lending – which banks, family offices and wealthy groups of people have been doing for centuries – fits the bill. Octopus is just trying to make it more “retail friendly”.
So what’s the investment proposition?
The quick run-down, as explained by Stuart…
The investor chooses the amount that they wish to invest, and those funds are then spread across a diversified portfolio of secured Dragonfly loans. The target rate of return is between 5 and 6%. There are currently 21 loans trading on the platform. No more than 5% of an investor’s funds will be allocated to an individual loan. Octopus handles all allocation and management responsibilities. The loans are made available on the platform through a blind allocation process, dependent on capacity. Octopus cannot cherry pick which loans are placed onto the platform. All of the loans are sourced from its proprietary deal flow.
Every loan is secured against bricks and mortar, to date residential property. Those loans are either bridging, buy-to-let, or bridge-to-let loans. The average term is around 9 to 12 months. Stuart described the loans as “very conservative”, pointing to the stipulated maximum LTV of 70%. The average LTV is around 62%.
Stuart says that, as the loans come from Dragonfly’s tried-and-tested deal flow, Octopus Choice is comfortable with going “one step further” and investing in the loans. 5% of the capital in each loan is contributed by Octopus, in a first loss position, meaning that investors would get their money back before Octopus in the event of default. Investors also earn all of their interest before Octopus earns any for itself. The combination of the conservative LTVs and the first loss piece means that the “underlying asset has to fall 33.5% in value before any investors’ capital is at risk”, according to Stuart.
All Dragonfly loans are fully funded in the first instance by Octopus, and then syndicated out to investors on the platform. But how is Dragonfly itself funded? By a number of funding lines, sourced from institutional investors and via other Octopus products. Stuart explained that it’s important for Octopus to fund loans in the first instance in order to bring speed and consistency to the borrower experience.
Winning over advisers
Peer-to-peer lenders have worked hard over the years to crack open the adviser space. But the prevailing market sentiment is that such efforts are yet to bear fruit. An Intelligent Partnership report from December last year revealed an endemic lack of awareness about the alternative finance sector within the advisory community. The headline findings were that 27% of alternative finance platforms had no plan in place for marketing to Independent Financial Advisers (IFAs). More concerning, however, was the fact that only 7% of the advisers surveyed realised that the many different moving parts of the alternative finance industry were and continue to be regulated.
There’s still a fair gap between the advisory community and peer-to-peer platforms, but no such gap exists for Octopus. Richard explained: “Our core business is to help financial advisers to help their clients. Octopus Choice has been built as an adviser friendly product. Will we explore a direct to consumer version later down the line? Yes. But right now the focus of our efforts is on creating the first P2P product that really helps financial advisers help their clients access the benefits of the P2P market.”
Octopus has spent 15 years slugging away at cultivating relationships with thousands of advisers. Stuart sees that as a strategic advantage that’s tough to replicate. “Financial advisers have huge responsibility,” he said, adding that they are naturally over-cautious when engaging with emerging asset classes. Richard says the key to winning over the advisory species is to ensure that investment products do what they say they are going to do. In other words, predictability and consistency are perhaps more important than delivering the “best” returns on the market. Octopus has spent 15 years establishing a reputation for dependability. Richard believes that some of the more nascent P2P platforms simply “don’t have enough track record” to win over advisers.
But is there anything practical that Octopus Choice is doing to suit the needs of the advisory community? “We understand how financial advisers work,” said Richard. He said that the key is to build products which help them to handle their compliance, time and cost requirements as easily as possible. Richard says that Octopus has leveraged its experience in developing other products and has built the Octopus Choice platform accordingly.
Returning to the first loss piece, Stuart believes that this is another feature which makes Octopus Choice a more natural fit for advisers. “The fact that we put our money where are mouth is and invest alongside investors in a first loss position has been very encouraging for advisers. At Octopus we always work hard to ensure our interests are aligned with our customers, and advisers value this,” he said.
Transparency and the wider P2P market
Transparency is often pitched as something of a silver bullet in the wider peer-to-peer lending market. Most platforms operate as pure intermediaries, and do not invest any of their own capital in the loans that they originate. But they would argue that the fact that they publish full loan book data online sufficiently aligns their interests with those of their investors. The logic is that any problems in the underlying loan book will quickly come to light, thereby killing off investment flows for the platform.
Given that Octopus Choice will have monetary skin-in-the-game, do Richard and Stuart still see a role for transparency at the loan book level? Richard explained: “We’ve shared our historic Dragonfly data with some due diligence companies, who’ve looked at it and who have written third party independent due diligence on Octopus. What we’re going to do going forward is we’ll be very transparent on the loans that have gone through the platform as we scale up. In time, we will share the performance of the loan book, as other peer-to-peer platforms do.”
Does Octopus Choice intend to align itself with the broader peer-to-peer sector? Richard explained that financial advisers like to have choice (i.e. a basket of investment options) within their chosen asset classes. They like to be able to compare and contrast products on a like-for-like basis. “We developed tax products at scale before anyone else did,” said Richard. “What we’ve seen is that advisers often like to contrast you with someone else. Very openly we would welcome the other platforms building up their presence with IFAs, and opening themselves up to more scrutiny”. Richard believes that this process would allow advisers to create a risk spectrum within P2P, and to better understand the market. He was also clear in the belief that what Octopus and others are creating is a new asset class: “Secured asset backed lending is a new asset class like equity or cash, like corporate bonds. It’s a new asset class that has a great appeal for financial investors. But at the moment the choice is limited. Let’s be really clear here, if we’re the only provider, this is never going to be a big asset class”.
There are two types of advisers – whole of market and restricted. The former has to give a fair market view to clients, the latter works with a limited range of products, but has to make that clear to clients. Since the beginning of the new tax year, advisers have had the right to advise on P2P investments. However, they are not required to consider P2P when offering a whole-of-market view. Nonetheless, it’s crucially important that advisers are able to demonstrate that they’ve performed sufficient due diligence on products prior to investing client funds. That’s another key consideration in Richard’s desire for Octopus Choice to be just one part of a larger and more sophisticated peer-to-peer sector.
Finally, on the subject transparency, how does Octopus make money? There are no fees for investors on the platform. Octopus makes its money in two ways. The platform charges the borrower up to 0.35% per month in order to lend, and then earns a return of 20-30% on its first loss strip.
Although it’s starting out with Dragonfly loans, Octopus may well look to branch out its P2P offering down the line. “If we in the future felt that there was another secured asset class that we believed had similar characteristics, where we felt compelled to take a similar position and put our money where our mouth is, we would talk to investors and financial advisers and seek comfort that that would be something that they’d be interested in,” said Richard. He sees this kind of expansion as potentially important in driving the asset class into the mainstream. Octopus Investments has other Dragonfly-like lending businesses. The company also finances solar sites and healthcare infrastructure. These operations could well come with a peer-to-peer front-end attached down the line, but that wouldn’t happen without Octopus first speaking extensively to advisers about their appetite for such products.
The Octopus Choice platform is now alive and kicking. The company is allowing individual clients to register their interest, and is gradually inviting them onto the platform. But there’s still a fair bit of testing taking place. For now, Octopus’ efforts are focused on the adviser front. “We have taken advised money onto the platform, both personal and corporate, and we’re continuing to put our efforts there for the moment,” explained Richard. Stuart added that Octopus initially unveiled the product to its c. 500 employees, and saw “positive uptake”.
Bottom line? The way that Octopus thinks about “P2P” is interesting, and reflective of a trend that we’re seeing across the space. Said Richard: “P2P is a way of facilitating secured asset backed lending, on a fractional basis of ownership, to retail investors. For us, it’s another way of helping financial advisers and their clients to access an attractive market.” Octopus has selectively adopted the front end of the marketplace lending model, marrying that medium with its existing strengths to create an intriguing new form of investment. But make no mistake! “We’re not a marketplace, but we are offering access to our proprietary deal flow and exposure to markets where we believe our investments can really make a difference,” said Richard.
AltFi is returning to Amsterdam for its second annual Summit in the city. The inaugural event last year was a roaring success, with key figures from across Continental Europe's alternative finance and digital banking sectors highlighted. These included Jeroen Broekema, managing director of Funding Circle Netherlands, and Mieke van Engelen, head of innovative partnerships at ABN AMRO's standalone lending platform, New10.