By David Beacham on 8th May 2018
Goji's head of distribution David Beacham takes a look at the potential advantages of investing in direct lending, if only advisers understood it.
Prior to the global financial crisis, the assumption went that if clients had a mix of equities and bonds in their portfolio they would have something truly diversified. If equities went down bonds provided protection and vice versa.
Then, in 2008, pretty much all asset classes went down in tandem, and investors who thought they were diversified and protected were anything but. Ten years on and one of the great challenges for the investment industry has been to find assets that are truly uncorrelated to each other. It’s been described as the holy grail of investment. As a result, many have turned to alternative classes, with property, absolute return and alternative Ucits products all proving popular.
However, while these asset classes receive a lot of attention, others can often get ignored, or simply be missed. One such asset is direct lending, or alternative credit, as it also labelled. Despite being a £14bn industry, of which £4bn was accumulated in 2017, it is an area which is probably better known by clients than their financial advisers.
To date some 200,000 retail investors have invested in the direct lending space, yet few have received traditional advice. With the number of investors growing at a fast rate, there is a real risk to the adviser community that if they do not understand this market they will see more of their clients make their own decisions without them.
Bringing alternative credit into the advisory sector
Lack of regulation was previously a key factor putting off many IFAs from using the sector, but all this changed with the advent of the IFISA. It was a key milestone because being a government endorsed tax wrapper, it gave direct lending a sense of credibility. Yet many IFAs remain uncertain about alternative credit.
Part of the reason advisers may not be on board is that they simply don’t understand what direct lending is, and how it can provide diversification. Take the global financial crisis in 2008. At a time when equities, bonds and other asset classes were all falling in tandem, Zopa, one of the largest peer-to-peer lenders which focuses on consumer lending, returned a positive 5%.
Investors currently using direct lending are using the asset as an alternative to cash, but importantly not from a risk perspective. We call it ‘fixed interest plus’. It is an asset that generates income from credit assets (namely loans) which are not directly impacted by changes in market sentiment or pricing like traditional fixed income products, such as bonds.
Such are the uncorrelated benefits of the sector that well-established fund managers, such as Neil Woodford, Blackrock, L&G and Aviva, have all been active in the space to provide diversification to their portfolios. However they, like many of the 200,000 already using direct lending, just invest in a handful of loans in one or two sectors, typically consumer or SME lending. The result therefore is more exposure to the risk of default and deferral.
The key to moving the sector’s offering forward therefore, is diversification and due diligence. Speaking from Goji’s perspective, we invest in secured loans, not the consumer lending space, which provides a higher quality of credit. We also do our due diligence, applying risk analysis models that any professional asset manager would be familiar with. Finally, we typically invest across 500 to 1,000 loan partsacross a range of sectors, such as SME lending, property lending, asset-backed agricultural lending and education finance.
Education, Education, Education
A number of prominent bond experts, including Bill Gross, have predicted an upcoming bear market for bonds whilst others believe that equities may be in for a bumpy ride after 8 steady years of growth. Alternative credit is perfectly positioned therefore, to add genuine diversification to portfolios when it is really needed.
The job for all of us – that is, professionals working in the alternative finance sector – is to support those advisers that are keen to be educated and who also admit it may be an area they know less about than their clients.
At Goji we believe this new asset class should be considered a small part – no more than 10% – of a client’s overall wealth solution. As such, the question we pose of advisers is, given that every asset should first be ruled in to every piece of advice, do you understand direct lending well enough to rule it out?
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.