Alternative Finance for Income Investors: A Survey of Market Lending

Like a volcanic island emerging from the sea, a new and largely uncharted territory rich in opportunities for income investors has been unfolding at internet speed during the past several years. This new territory is just in time, as the traditional alternatives for income investors (bank deposits, bonds, income funds and trusts) no longer provide acceptable returns due to the near zero interest rates policies adopted and maintained by the world’s leading central banks in response to the financial crisis of 2007-2008. These low interest rates have driven the return on money invested in a prudent manner – consistent with conservation of capital – to low levels not seen in many decades. At present the government bond yields of many countries are lower than they have been at any time in the last several centuries. Given this discouraging panorama for savers, what is a person to do in order to obtain a rate of return on their hard-earned savings which not only exceeds the

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In recent years, internet-based, non-bank market lending platforms have undergone exponential growth in the US and the UK, and are now emerging worldwide. With much lower operating costs and regulatory burdens than traditional banks, these platforms have the potential to disrupt our familiar bank-centred capital allocation models, where savers deposit their funds in banks that in turn make loans to earn an interest margin on the difference between the interest paid to depositors and that which is charged to lenders.  Though now very small in comparison to banks, the total volume of transactions completed by the leading market lending platforms is growing at a very rapid pace and is projected to reach a significant portion of all lending activity during the next decade. The alternative finance industry non-bank players are already reaching beyond their P2P consumer finance origin to begin to seriously challenge incumbent banks in other broad areas of traditional merchant banking such as small business lending (P2B), discounted invoice financing, trade finance and real estate mortgage loans. Each of these new islands of alternative finance market lending provide unique benefits and challenges to income investors with the will to venture beyond the more familiar P2P or P2B platforms to diversify their sources of returns as well as reduce overall risk.  

This series of articles will initially examine the origins of market lending and the exponential growth of the leading platforms in recent years. An overview of each of the key areas of Alternative Finance will first be presented (Peer-to-Peer consumer lending, Peer-to-Business SME lending, discounted invoice financing, trade finance and real estate mortgage funding). Later articles will examine the potential of alternative finance and bank disintermediation to disrupt the current model of capital allocation. Further, the challenge of alternative finance to traditional investment management will be evaluated.

Finally, the positive impact of more efficient capital allocation on the real economy will be examined in the context of a future where central bank interest rate mechanisms and political priorities (e.g. the need for low interest rates) will no longer dominate the capital flows to productive enterprises. As an added benefit for investors, it is clear that alternative finance represents “ethical investing” in the truest sense of the term, as investors can choose from among the various alternatives to earn income through market lending and have the satisfaction of knowing exactly where their savings are going, and exactly what they are financing. This stands in sharp contrast to traditional income investing that largely finances huge corporations, government deficits and financial executive bonuses. 

Throughout this journey it will be my good fortune to be able to count on the extensive resources of AltFi Data to access the most up-to-date information on trends in the Alternative Finance space. Additionally, I will rely on continuing input and feedback from the very talented people I am privileged to work for each day. These people are my clients, who have trusted me to advise them on how to secure acceptable returns on their savings despite the lasting very low interest rate environment that has made savings through traditional methods an exercise in futility. The satisfaction of my clients with alternative finance market lending has motivated me to become an evangelist for this cause, eager to help advisors and their clients to make the journey to the better place of alternative finance income investing.  I have no doubt that alternative finance income investing is far superior in almost every respect than the current offer on hand for traditional income investors, where it too often seems that all parties concerned earn a decent return, with the exception of the investor. 

It is my hope that over the course of the next several months I can serve as guide to investors who are willing to make the leap from the familiar but unprofitable world of traditional income investment to accompany me on a survey of the new alternative finance market lending sources of predictable, attractive returns on their savings. This new territory is actually very similar to an earlier territory for savers before the banks shifted their focus from satisfying the needs of savers and borrowers to their current role as providers of services to governments and large corporations. That shift rendered the banks unable to dedicate resources to provide loans to SMEs or worthwhile returns to savers. While the territory is new, the tools that I bring to carry out this survey are the same as those used by traditional investment advisors, that is, measurements of risk, returns, and strategies of diversification in order to minimize those same risks. The difference is that while traditional income investing increasingly requires the acceptance of greater risk, longer maturities, lower quality assets and bloated valuations in the search for yield, alternative finance market lending investors have a varied and growing number of options to choose from, offering both attractive returns and security for their capital. These options run the spectrum of market lending from P2P consumer loans, P2B business loans, discounted invoice lending, trade finance and mortgage based lending. Each has its particular risks and rewards, and each is worthy of a more detailed treatment and exploration in upcoming articles.

This guide very much hopes that you will join him on the upcoming expeditions to these new islands of opportunity – a voyage to be made by income investors who are willing to consider the advantages of alternative finance market lending in order to obtain a better return on their savings without assuming excessive risk to their capital.  

Questions or comments? Email james.levy@synthesis-sif.lu

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