In the last two articles, we compared P2P lending to traditional investments in stocks and bonds. One of the key takeaways was that P2P loans are great to invest in actively, i.e. to choose loans in the portfolio yourself: the platforms are easy to register at, browsing through the available loans is very intuitive, and you don’t need a lot of capital or experience to start. This stands in quite sharp contrast to traditional investments, including stocks and bonds – to trade them directly, you need to use brokering services, which can be both costly and complicated; not to mention you have to be prepared, both strategy-wise and emotionally, for the markets’ ups and downs.
But relatively few people invest in stocks and bonds this way – much more popular is investing in funds or trusts, which provide ready-made portfolios of financial instruments (be it stocks, bonds, gold, or other). Can this fashion of investing be adopted in the P2P lending context? And does it make any sense, given the ease of active investment?
How do Funds & ETF's work?
Essentially, putting money in an investment fund, you invest in a portfolio compiled by the fund owner/manager. The funds can comprise of one asset class (e.g. a range of company stocks) or many (a compilation of stocks, bonds, fixed income assets, etc.), can be specialised (e.g. focused on high-tech unicorns) or highly diversified across sectors, risk categories and geographical locations. They can also vary in ways they are bought, sold and managed. The two key types (and also, most relevant for our analysis of P2P lending funds) include:
- Exchange-Traded Funds (ETFs) and investment trusts are listed on the stock market, just like any public company. Investors willing to invest in a particular fund, simply buy its shares through a stockbroker.
- Mutual funds are financial vehicles made up of a pool of money collected from investors, who buy and sell units of a fund.
Another key feature is how the fund is managed:
- Passively managed (or indexed) funds simply follow an established one of the major indices like the S&P 500 and automatically sell the stock that’s leaving and buy the stock that’s becoming part of the index.
Actively managed funds pick and choose the most promising assets, based on much deeper analysis and expertise of a portfolio manager, with an aim to beat the market’s average returns (the index). They involve much higher fees than indexed funds (to cover the research and expertise costs), but can potentially bring higher returns.
Ups and Downs of P2P Lending Funds
The first chapter in the history of P2P lending funds starts with big promises and a huge boom but ends with a rather resounding failure. P2P Global Investments (P2PGI) kicked off in 2014 as the pioneering P2P lending investment company and, riding on a wave of (over-)enthusiasm, raised £850 million in its first year. It then failed to invest the capital well, missed its dividend and the 6-8 per cent annual total return target, which resulted in sinking share prices. The following years brought discord and strife for the new-born sector, with investment trusts popping up and disappearing, and more established players (such as P2PGI) struggling to retain or regain investor trust.
It seems though as if after the initial dark years, the P2P lending investment trusts seem to have moved up the learning curve, recovered, won back some investors and stabilised. In 2019, P2PGI rebranded as Pollen Street Secured Lending (PSSL) in an apparent attempt to break away from the shabby past. The major investment trusts, including Honeycomb (HONY), VPC Specialty Lending Investments (VSL) and PSSL, have also proven their worth, delivering returns between 20 and 30 per cent since inception up until mid-2019…
…And then the pandemic came and dragged down the sector once again. Although the COVID-driven downturn’s total effects on the industry remain to be seen, it’s pretty clear that the trusts are going to be hit much more severely than P2P platforms, combining negative effects of loan defaults with the stock market slump. Virtually all stock-traded funds have seen sharp declines. Probably the best illustration is the Amplify CrowdBureau Peer-to-Peer Lending & Crowdfunding ETF (LEND), which kicked off in September 2019 as an indexed fund following the CrowdBureau Peer-to-Peer Lending and Equity Crowdfunding Index – it has lost almost 45 per cent value in just a year.
P2P Mutual Funds - Safe Haven?
P2P lending mutual funds provide a somewhat less dramatic story. Although we lack robust, systematised and/or up-to-date data, it seems they attract both fewer capital volumes and, surely, much less attention than P2P lending ETFs and trusts.
Let’s take as an example probably the most established and well-performing fund out there – the Symfonie P2P Lending Fund. Launched at the end of 2013, it offers two portfolios with three- and five-years investment horizons. The fund is managed (very) actively and includes carefully chosen and highly diversified loans. The strategy seems to be working well – by the third quarter of 2018 (that’s over less than four years), the two portfolios grew by 35 and 45 per cent respectively, bringing an annualised return of 6.5 and 8.5 per cent with little fluctuations over time. AltFi’s P2P Lending Fund is another fund worth following – launched in 2019, it has a very similar underlying strategy, offering two- and five-year portfolios and promising an annual return of 5-7 per cent.
Should you invest in P2P Lending ETFs, trusts and/or mutual funds?
The short answer would be “yes” for mutual funds and “no” for trusts and ETFs.
Let’s start with the latter – investing in funds traded on the stock exchange has very little to do with P2P loans. Effectively, investment in P2P lending ETFs and trusts equals investing in (P2P-sector-exposed) stocks. You give up virtually all key benefits of P2P lending investment (see our previous articles comparing P2P lending to stocks and bonds) and get not only all the drawbacks of stock investment (high volatility, sensitivity to economic shocks, etc.) but also a pool of stocks that are exposed to a single sector, i.e. very poorly diversified. If you like the risk and returns of the stock market, you’re probably better off investing in more generic indexed funds (e.g. following the S&P 500) or trusts that are better diversified across sectors and locations.
Mutual trusts, on the other hand, can provide a significant edge over investing in P2P loans yourself. For one, they can save you time picking loans for your portfolio. They are professionally managed and potentially have better access to information – fund managers can often get more information from P2P platforms than individual lenders do. This information advantage can help them select the right P2P lending platforms and borrowers more effectively. They are able to diversify the portfolio across borrowers, countries, sectors, yields and maturities to an extent that is not achievable for most individual lenders (e.g. the Symfonie Fund invests in approximately 450 loans across four platforms). All this translates into above-average returns (6.5-8.5 per cent, compared to an average of 4-8 per cent).
Clearly, there are some setbacks as well – investing in a mutual fund, you still need to forsake some important benefits of investing actively in P2P loans. There are higher time and capital restrictions – maturity of funds varies from two to five years, and there are usually caps for the initial investment (a minimum of €2,000 for the Symfonie Fund). Liquidity and cash flow are minimal – forget about monthly repayments and secondary markets. You also lose the opportunity to learn and have fun building your portfolio. Most of all though, the professional conduct of mutual funds’ managers has its price – for example, the Symfonie Fund charges investors management fees of 1 per cent for the 3-year portfolio and 1.25 per cent for the 5-year one, and an administrative fee capped at 0.75 per cent.
In sum, if you like to add some high-risk assets to your portfolio, you’re probably better off investing in generic/well-diversified stock-focused funds rather than putting your money in P2P lending ETFs, which have a very patchy and rather disappointing record so far. On the other side of the risk spectrum, if you want to play it ‘safe’, you can give P2P lending mutual funds a try. They are run by professionals, who will pick a well-diversified portfolio of loans for you and ensure relatively high returns with little volatility. Remember though that, on top of the rather high fees you will be charged, it might also be a fun-killer – the ease of investing actively through P2P platforms is one of the best perks of P2P lending (at least in my view!)