By Ryan Weeks on Tuesday 12 August 2014
Part 2: Investors
Moving onto the investor-facing part of the discussion. I want to issue the initial caveat here that I am well aware that the vast majority of individuals within the age range of 18-25 years old are unlikely to have much, if any, spare cash lying around. More to the point, with limited funds they’re going to have to be pretty disillusioned with mainstream savings products to consider branching out into the world of investment – alternative finance-based or otherwise.
But equally, whether or not it is entirely appropriate, there absolutely will be some adventurous young sorts who start searching for a little extra bang to their fairly limited bucks. And this section of the guide is for those people. It is by no means a call for 18 to 25 year olds everywhere to start piling the entirety of their limited disposable income into alternative finance.
So, onto the options…
The invoice finance sector can almost be dismissed out of hand here. As I’ve already alluded to, 18-25 year olds are highly unlikely to have enough spare cash to be able to justifiably meet the lofty minimum investment amounts required by platforms like MarketInvoice and Platform Black. These services are ideally suited margin-seeking institutions and highly sophisticated investors – able to put a minimum of £50,000 to work through the platform. If committed, that £50k should be committed as a risk/reward portion of diversified portfolio.
That isn’t to say that invoice finance investors are likely to lose their principle – they’re highly unlikely to – but they could. The point here is that this isn’t a savings product. The majority of individuals within the specified age range (18-25) are pretty unlikely to have £50k in idle cash full stop, let alone £50k that they could afford to lose. Both UK invoice platforms only accept sophisticated investors anyway – of which very few will be under 25 years of age.
In the equity crowdfunding sector there in fact is some scope for the involvement of youthful investors. The primary reason for this is the extremely low minimum investment amounts. To acquire a slice of a growing business through the Crowdcube platform, you only need to put up a measly £10. Startup investing is intrinsically risky and equity investments offer no guarantee of ROI or even of the recovery of principle. Investors – and this really applies to users of all ages – have to be prepared for the worst to happen. Nonetheless, I could imagine many a fledgling investor being tempted by the idea of acquiring a stake in the next global phenomenon – and it could happen. But you have to be a realist when approaching the equity space, particularly if your funds are in short supply – as they generally will be for those within my age range.
FCA regulations state that retail investors may pump no less than 10% of their investible assets into equity crowdfunding. If tempted to have a punt, I’d suggest that the limit that under 25s should impose upon themselves should be even lower – perhaps with an uppermost cap of 5%.
And then we come to peer-to-peer lending. On the investor side, this sector – which incidentally is the largest and most developed of the alternative finance markets – represents the most enticing opportunity for younger folk. The key distinction that has to be immediately understood is that allocating your money to a peer-to-peer lending platform is not the same as putting your money into a deposit account with a bank. You are not FSCS protected and there is a risk– no matter how slight it may be – that you could lose all of your money.
The major UK platforms generally boast a highly impressive track record in terms of default rates. As far as I’m aware, none of the P2PFA member platforms have higher than a 3% default rate. A number of platforms – like RateSetter, Zopa, and Wellesley – have provision funds in place. This means that if an underlying borrower does default, the platform may be able to dip into that contingency fund in order to recoup your losses. Up to now, no investor has ever lost any money at all by using the RateSetter platform.
But do not take that to mean that there’s no chance that you will. There are two major factors to be considered here: the maturity (or immaturity) of the platform’s portfolios and the benign state of the economy at present. As Rupert Taylor recently explained in his excellent column on the subject, younger loans are less likely to default – so it’s hard to gauge the quality of a particular platform’s lending with absolute certainty at this early stage in their existence. Perhaps more importantly though, none of the UK platforms – with the sole exception of Zopa – have yet been through a period of economic downturn. Contingency funds may not be able to hold up as well under the stress of a recession – at which point the underlying quality of a platform’s lending becomes all the more important. These two factors point to the same end conclusion – lending through P2P is not risk-free.
You needn’t fear risk, you just need to understand it. 18 to 25 year olds typically don’t have a lot of money – and the larger part of any savings that you might have accrued is probably best housed in a bank account. But many young earners out there will be keen to trial a few slightly more adventurous avenues for putting money to work. Peer-to-peer lending is one such avenue. It offers young lenders returns that vastly out-perform those of a standard deposit account – on average somewhere between 3% and 15% per annum (though highly dependent on the platform). There is a level of risk involved with all P2P platforms, but it is an acceptable level of risk – provided that you’re not tying up the bulk of your savings through P2P.
And finally, whilst the fundraiser part of this discussion focused mainly upon entrepreneurial sorts, the majority of young adults will in fact end up working for established companies. Some of those companies will be asset managers, VCs, hedge funds, advisory firms – and so on. And for all the budding employees that do end up working for such a business, know this: alternative finance is on the rise, and it will become increasingly important for you to possess an understanding of its various forms.
2014 has been a year of unprecedented growth for the industry. According to AltFi Data, the UK P2P and online invoice finance sectors have now supplied upwards of £1.8 billion for businesses and individuals. The growth trajectory for the space is exponential – and the industry will likely be well on its way to £3 billion by the year’s end. With ISA and SIPP inclusion for P2P confirmed, a specific FCA regulatory regime in place, the emergence of dedicated peer-to-peer funds (P2P Global Investments), and a swell of government support – alternative finance in general represents an increasingly legitimate asset class. That makes it pertinent for a whole new stratum of young people who are working or will work within the world of finance.
When I set out to write this two-part piece, the goal was to highlight the relevance of alternative finance to younger people and flesh out various ways in which those people might approach the many platforms. It’s important for younger people to be armed with an appropriate blend of information and caution about an industry which, as discussed, will likely reach its zenith during their professional lifetimes. The overarching point is that whilst alternative finance is currently buttressed chiefly by the middle-aged – there are ways for young people to interact with this exciting space that are perhaps worth consideration, but that are undoubtedly worth having an awareness of.