The income opportunities in alternative credit

Goji's David Beacham reveals why financial intermediaries as well as institutional investors are increasingly paying attention to the fast growing alternative credit universe.

Last month Goji was the lead sponsor of the Altfi Alternative Credit Summit, and it was a proud moment for all of our hard working team. As a specialist alternative credit investment platform, it was wonderful to see our name and brand in lights at Altfi’s inaugural seminar – ‘Income opportunities in alternative credit’.

The event was attended by an audience of informed credit and investment professionals, who all arrived with their own varied predictions as to what the future holds for us all in the current investment landscape – a landscape that continues to be fraught with uncertainty.

Common held views were that investors are currently challenged by a number of factors:

• Perceived high equity valuations that are likely in store for a price correction at worst, and struggling to gain further multiple enhancement at best.
• Yields on traditional fixed income are close to historic lows despite managers journeying higher up the risk curve.
• Interest rate risk which remains not only high, but likely to go hand in hand with quite remarkable volatility with no sign of central banks winding down their expansive monetary policy.
• Lo betide we mention inflation, which may finally rear its head meaningfully for the first in a number of years, and this is without mentioning the impact of the upcoming European political calendar with French, German, Italian elections and Brexit negotiations…

It’s at times like this when risk management becomes a thankless task but where the job is more important than ever…

…cue the alternative credit sector coming to the rescue.

It was unanimously agreed that this sector has most definitely arrived and we saw this demonstrated through the views of our speakers at the event. Such evidence being:

• The sector has its own ISA
• There has been over £6.5bn raised on the stock market
• There are over 250,000 retail investors participating in the sector

All this said, there are still questions as why more mainstream advisers are yet to embrace the sector. We at Goji undertook some substantial market research in the IFA & wealth management sectors late last year, and the results were quite startling. With 20 per cent of advisers having never heard of the asset class and only 5 per cent of advisers being fully aware of the Innovative Finance ISA, combined with over 55 per cent of them having clients approach them to discuss it……

Frankly, I certainly believe that it is time for investors and managers to get to grips with a world where technology advances and banking regulations now mean that large portions of the economy need financing…and offer an attractive return for doing so. To quote a recent comment from KKR, one of the world’s major asset managers:

“The illiquidity premium for alternative credit is outsized - investors can pick up substantial yield boost without having to take substantial duration risk or credit risk. The long duration economic cycle, with periods of outsized government-induced market volatility, could provide alternative credit managers with an opportunity to capture attractive yields”.

 So, the challenge remains, as with all emerging asset classes, and it is one that we must, to an extent, embrace. At the event our panel session was with Proplend, Ratesetter and LendingCrowd, and unsurprisingly we were all agreeing that P2P was a natural fit for wealth managers, but we left the audience to judge whether we convinced as to the risk and maturity of the market as a whole.

Whilst we may have disagreed on some points, it was clear that whilst challenges remain, professional advisers and managers are starting to take note…to put it into context - retail participation in P2P/ direct lending is now bigger than the VCT and EIS markets put together and although the sector is less than half as old, surely the alternative credit sector has a bright future with the intermediary market, especially in a hunt for yield.

The big questions are therefore, how do managers and advisers, in the face of persistently low yields in traditional fixed income, and on non-existent returns on cash, in times of likely market volatility and returning inflation, use Alternative Credit, in its many forms, to help their clients to meet their investment objectives?

No matter what the view, alternative credit is here to stay, as advances in technology and bank retrenchment and investor confidence provide tailwinds to an increasingly entrenched alternative credit sector.

I firmly believe that advisers and intermediaries need to get to grips with this sector, and specifically, explaining new lending structures, the illiquidity and alpha risk to clients. It is incumbent on providers, such as Goji, to make that easy for them, and that is what we intend to do!

It was extremely interesting to see from events and audiences such as this one, that utilising and investing in alternative credit is blindingly obvious, but we know we need to demonstrate more prudence than that…equally we are not seeking to advocate the alternative credit sector by default because we should run for the hills at the first sign volatility, inflation or asset pricing corrections.

The sector continues to perform admirably and continues to mature and is becoming increasingly prevalent within investors’ portfolios - so managers and advisers need to ascertain how they get comfortable with the asset class. The key education elements for advisers and managers is that they need to understand where alternative credit fits within the portfolio, which structures and products are appropriate and how they demonstrate that a chosen investment / manager is suitable for their clients.

All of this with being fully cogniscent of the risks involved and comfortable in the processes around how they seek assurances around and from new managers, how they guard against downside risks that, to be simplistic, the sector hasn’t yet faced in its new, boisterous and assertive form. Especially against a market landscape that is due to encounter significant geopolitical turbulence over the coming years!

For me, this event completely reinforced the sectors strengths, and provided further depth around the asset class and dispelled some of the myths in the process.

I will finish with a couple of predictions, albeit fairly obvious ones, that will drive and define the sector:

1. There will (at some point inevitably) be a market crash, and whilst the sector might welcome one as way of demonstrating its strength and maturity, we ought to be careful what we wish for.
2. Bigger, more numerous and more diverse vehicles, will arise to give more diverse and more informed investor base an opportunity to participate in alternative credit therefore improving confidence.
3. As the sector’s lenders mature, they will become increasingly sophisticated at pricing risk, and increasingly willing to tackle more diverse borrower segments.
4. Borrowers will continue to accept non-bank finance, Capital providers or their lending partners, will engage with increasingly sophisticated partnerships with incumbents and the Regulators will start to even the playing field with both positive and negative impacts - talk of ‘regulatory arbitrage’ will fall away, alternative fund structures will be more diverse and mainstream structures engaging more investors, retail investment vehicles such as SIPPs will open up.

Crucially, for investors and borrowers alike, if alternative credit does become mainstream, then the financial sector will become more resilient as credit markets become less dependent on heavily entwined banking relationships and investors’ portfolios will become more resilient as they get to grips with the sector and add further diversification and more counter cyclical assets to their portfolios…Now that can’t be a bad thing!

To conclude, I firmly believe that the future is bright for this sector, but work is still to be done.