Will US Rate Rise Hit Peer-to-Peer Lending Sector?

The peer-to-peer lending sector offers income investors yields of up to 7%. But investors need to be aware of potential risks on the horizon

Karen Kwok 9 February, 2017 | 3:55PM

Peer-to-peer (P2P) lending has offered some attractive return to income investors in recent years. While investors can gain direct exposure to the P2P sector, many choose to invest through specialist investment trusts.

Rising interest rates in the US could hit this sector – but Simon Champ, manager of P2P Global Investments (P2P) told journalists in London on Wednesday that he is not unduly concerned about the effect this will have on returns.

“As the average life of the loans we own is very short – that is about one to three years -  we are able to steer the book even if economic policy changes. We can get back 3-4% of loans in a month, coming back in cash and reapplying that to other loans. So we are not worrying about what is happening in the US as we have the ability to move the trust weighting to different areas as a fiduciary,” he added.

Concerns have raised in the industry on the peer-to-peer lending vehicles’ ability to withstand different economic conditions. The first company that offered peer-to-peer loans launched in 2005, and since then the P2P lending sector has benefitted from an ultra-low interest rate environment. This has encouraged savers to lend money through these sites, in a bid to get betters than they would get on cash deposits. It has also meant loans remain affordable for borrowers. But how will this sector fare when conditions change?

Holly Cassell, assistant manager on the Neptune UK Opportunities and UK Mid Cap funds previously told Morningstar that it is unclear how will peer-to-peer fare once rates raise and credit conditions worsen. Trevor Greetham, head of multi-asset at Royal London Asset Management shares Cassell’s views, as he believes the sector has not been tested through the economic cycle.

Are Yields in P2P Trusts Worth The Risk?

Champ admitted that the current economic climate has helped to grow peer-to-peer lending services.

“We have not always been in such a healthy and safe economic environment. Today, consumer confidence remains high, unemployment is close to an all-time low, and many people have equity in their home in the UK, cash savings or other assets.” He pointed out that this means there is often little difficult servicing a loan. “I think we are in a relatively unique financial position today compared to the last 100 years,” said Champ.

Champ says he is not too worried about interest rate rises; the risk he is most concerned about is a sharp rise in unemployment – particularly on a global scale.

“Half of our fund is consumer-lending, with the average loan size at less than £10,000.” An significant increase in unemployment could affect people’s ability to repay this debt, says Champ.

“If wehave another 2009 financial crisis, then I don’t think we will make much money, to be honest. But we would strive not to lose any in these circumstances. This is why we look for the strongest funding platforms to work with and seek out quality loans,” he adds.

To reduce these risks, Champ says the trust looks to increase diversification. Champ says the trust has investment in lending platforms in New Zealand, Australia, US and the UK – countries which all have strong banking environments and data.

However he says he doesn’t invest in Asia – at least at the moment. “I am obsessed with regulation. I want to work with platforms in countries where this is healthy and stable regulation, and these P2P lenders understand that they are not banks. Therefore, Asia is not for us just yet.”

One of the funding platforms the trust is working with is the San Francisco-based LendingClub (LC), the world’s biggest peer-to-peer lender. Champ said the company offers 36 different credit ratings that are attached to different interest rates. This provides lenders the opportunity to choose different risk and reward profiles.

For P2P Global Investments, the platform gives them the opportunity to focus on a very low-risk strategy and high credit rating loans, which Champ believes this can help the trust to weather any downturn in the wider economic cycle.

Champ added that the liquidity of the investment trust works very well for investors. Investing directly in peer-to-peer loans is far more illiquid.

Can Banks and P2P lenders Get Along?

Champ also stressed the “amazing transparency” peer-to-peer lenders vehicles have, when compared to the banking sector. However, he believes in the long term, banks and peer-to-peer lending platforms will coexist comfortably within the same market.

“Bank regulation changed a number of years ago, to protect retail depositors. But greater regulation  has made it difficult for banks in other ways. Therefore, I believe in the long term banks will not fight back, instead they will coexist with peer-to-peer lenders. It is just like the retail stockbrokers sitting side-by-side with Goldman Sachs,” said Champ.

Sachin Patel, global co-head at Funding Circle SME Income Fund (FCIF) echoes Champ’s views, saying that peer-to-peer lending provides another channel for small businesses to access finance.

“The market is huge. There are small businesses going to their bank for a loan, but they don’t know where else to go for if this loan application is rejected.” This provides an opportunity for peer-to-peer lending platforms to provide credit services to these small business clients, said Patel.

Top Fund Managers Invest In Peer-To-Peer Sector

Peer-to-peer lending is an online lending platform that matches lenders directly with borrowers. The UK direct lending market is flourishing. Since 2015 the market is up by 39%, and by the end of 2016 was worth some £3.2 billion – according to data from BondMason, a UK-based direct lending service provider.

Investment trusts that invest in P2P lending are also booming. With attractive yields up to 7% for income seeking investors, P2P investment trusts have attracted the attention of a number of high profit fund managers. Data from Morningstar showed that Invesco Perpetual is the largest shareholder in P2P Global Investments with 30.2% holdings. Woodford Investment Management holds 9% of the trust, while Thesis Asset Management holds 7.5%. 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Funding Circle SME Income Fund Ord103.00 GBX0.98-
LendingClub Corp4.30 USD-0.92-
Neptune UK Mid Cap C Acc GBP1.69 GBP-0.18
Neptune UK Opportunities C Acc GBP1.71 GBP0.00
P2P Global Investments830.00 GBX0.24-
About Author Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk