Lending money to businesses is one of the key pillars of the alternative finance revolution. Outfits such as Funding Circle and Market Invoice focus on democratising finance for SMEs. Their central innovation is to provide a marketplace whereby individual investors can buy one – or even one hundred – bits of loans to a business. It’s a great innovation for income hungry investors looking to benefit from yields well above 5% per annum.
But it’s also indisputably true that this a riskier investment option. Lending to smaller businesses comes with the ever present possibility that your borrower might go bust and default. One can of course diversify between dozens if not hundreds of different businesses on a big platform like Funding Circle but at the end of the day you can’t diversify away the risk of lending to small businesses as an asset class.
Many investors might prefer to invest their precious capital in much bigger businesses. Sadly large cap businesses by and large don’t want smaller investors investing money in their loans and bonds. The few that do tend to direct investors towards bond structures, usually accessible through the London stock market. But this retail bond market as it’s called doesn’t have quite the full range of choice that I’d like. Many big institutional debt/credit specialists have a much wider range of choices and they prefer an alternative structure called loan notes. These are incredibly useful structures, sponsored and issued by big investment banks that offer what’s called senior, secured access to a corporate issuer’s balance sheet. Crucially they’re frequently issued by well-known brand names, with huge amounts of information available online about the underlying trading business. And these loan notes offer one last absolutely vital advantage – these structures offer floating rate payouts, usually built around a margin above LIBOR rates. That means that those income yields could go up (or down) if interest rates move, and/or inflation starts to shoot up.
Senior secured loan notes yield anywhere between 3 to 7% dependent on the issuer with durations ranging between a few years up to 10. Most retail corporate bonds by contrast are not floating rate based, many boast yields of less than 5% and more than a few are subordinated which means that there are other lenders who have a more senior claim on the assets of the business.
So, senior secured loan notes are an attractive form of credit in their own right. But the bad news is that ordinary investors – until now at least – haven’t been able to buy these individual loan notes. There are loans note funds trading as investment trusts on the London stockmarket, with one from Alcentra investing in European notes (ticker AEFS with a yield of 5.3%) and another from JPMorgan investing in US senior notes (ticker JPSL and yielding 5.6%). Both funds are an excellent idea for income investors looking for a more than decent income yield from an asset class that offers surprisingly low levels of volatility. Defaults are absolutely a factor – they spiked in 2009 and 2011 – but a good fund manager should be able to avoid the most obvious basket cases.
But in my experience many investors don’t want to go down the diversified fund route. The reason that platforms like Funding Circle have been so successful is that some investors like the DIY approach. They like to pick their borrowers, understand the unique risks of each business and then build their own portfolio of loans using that marketplace model. Loan note funds obviously can’t cater to this more discerning crowd but a new platform called WiseAlpha can. Founded by Rezaah Ahmad, a former senior secured loans trader, this is a novel take on the alternative finance theme.
In effect like Funding Circle it offers a market place where you can buy and sell loans to businesses. But the businesses on this platform are well known names like Virgin Media, United Biscuits, the RAC, Worldpay and Eddie Stobbart. Some are publicly listed businesses, others PE owned. The WiseAlpha platform started last week and at the moment has only these fine issuers, but by the end of the year that should be upto 15 to 20.
The duration of these notes goes from 2017 through to 2021 with yields ranging from 4 to 6%. – most notes tend to run what’s called a bullet repayment structure which means that you are repaid at the end of the loan note term.
Crucially all the notes on this online platform are senior, unsecured, floating rate notes from well-known issuers. Again like Funding Circle there is also an online marketplace where you can sell the loan notes – called a secondary market. This is built around a matched bargain structure which means you have wait until another buyer to come along who wants to buy your loan notes (you can’t sell these loan notes via your stockbroker like a retail bond). Investments can start from as little as £100 although my guess is that the bigger initial fans of this service will be high net investors and family offices – the platform makes its money by making a 1% platform fee for funds invested. It’s also worth noting that you do have to take an online test to prove that you know what you are doing and that you haven’t invested more than 10% of your total assets in this platform – again this is like many of the crowdfunding platforms.
There are some important considerations to bear in mind if you are thinking using this new fintech platform to build a robust income stream. The first is that you need to use the platform to make the trades. You can’t just ring up your broker or adviser and ask them to pop the notes in your SIPP or ISA. You also need to be aware that you are not in fact owning the exact same notes as the big institutional investors. The platform is structured so that WiseAlpha Ltd, administered by APEX Fund services (a big fiduciary admin specialist) buys the underlying notes and then in effect reissues them as WiseAlpha notes fully backed by the underlying corporate notes. The APEX connection should offer investors the surety that even if the platform goes bust, you’ll still own your underlying notes. Also that matched bargain secondary market isn’t as fully liquid as a stockbrokers account but hopefully as this platform expands over time, liquidity will vastly improve. Besides my guess is that many investors will prefer to hold the notes straight through to maturity. Also be aware that although volatility in the underlying notes is relatively low, issuers have and will default. Just because it’s a well-known name doesn’t mean that it won’t go bust – helpfully the WiseAlpha platform does allow you to dig deeper into the financials of the firm via an online due diligence process.
We believe that this new online platform is a cracking idea and its products absolutely could sit alongside both P2P loans and more conventional retail corporate bonds. It shouldn’t be your only source of income (far from it in fact) but if you are after that elusive robust, sustainable income yield from businesses you can trust (and research), WiseAlpha could be a cracking alternative home for say 10 to 20% of your income portfolio.