The arrival of platform funds will give investors more choice When alternative-finance providers such as Zopa first emerged in the middle of the last decade the business model was a simple market place. Each investor put their money online and chose which borrowers they wanted to lend to and what interest rate they wanted to lend at. But in the last few years that model has completely changed.
Investors within alternative finance are now faced by a range of options. Funding Circle, which caters to small-business borrowers, has stuck closest to the market-place model (think eBay but for investing). But Zopa and Ratesetter have moved closer to a pooled investment fund approach. Their focus these days is not on investors picking individual borrowers, but on selecting from a limited number of options based on how long you want to lend out your money.
Introducing the P2P fund
More recently, another option has arrived: the listed investment trust or fund. The first was P2P Global Investments (LSE: P2P), run by fund manager Eaglewood, which is now valued at more than £900m. This fund invests money through a range of platforms, including the big UK players and the US consumer-based platforms (Lending Club and Prosper) plus a longer tail of smaller outfits such as US-based student lender SoFi and UK-based Lendinvest and Assetz. The advantage of this fund-based approach is that you can buy into a very diversified range of underlying loans.
Now a new option is about to emerge in the UK – the platform fund. With this, you buy into a range of loans from just one platform, so at first it doesn’t look all that different from the pooled investment option already offered by platforms such as Zopa. But the key difference is that the fund will be listed and traded on the London Stock Exchange, rather than sold directly to investors. The biggest player in platform funds is likely to be Funding Circle, which has just announced that it hopes to raise £150m for its forthcoming SME Income Fund. This will invest in loans originated through the Funding Circle platforms, both in the UK and US, and will aim to return an annualised dividend of between 6% and 7% to investors. The fund will be passively run and will carry no fund-management charge – by comparison, P2P Global Investments and its main rival Victory Park Capital Speciality Lending Investments (LSE: VSL) both charge a management fee of 1% a year plus a performance fee.
Meanwhile, GLI Finance, a major player with platforms operating around the world, is also looking to launch its own fund. This will invest in its portfolio of platforms, with a yield likely to be in excess of 8% a year. (Disclosure: I may be a non-executive director on this fund if it lists.)
The idea of a platform-based fund is appealing for the more sophisticated investor, since you get to decide what you want to own. With P2P Global Investments and Victory Park Capital the fund managers make those decisions – so you may have a big slug of US consumer loans in your portfolio whereas you’d prefer UK business lending. Since platforms tend to focus on specific sectors – for example, both Funding Circle and GLI lend to small businesses – platform funds could give you more control.
I’d expect more of these platform funds to emerge in the UK, perhaps pushing us towards a US model called the Business Development Company (BDC). These first emerged in the 1990s as a tax-efficient way of investing in small firms. Nearly all the income received by these is passed on as dividends to the end investors without being taxed directly. There are now 50 of these BDCs, run by private-equity firms, venture capitalists and investment banks.
Lessons from the BDCs
Since UK-based investors in P2P funds could have something to learn from these US funds, it’s worth looking at the trends that have emerged in the sector. The share price of the funds is usually below the combined net asset value (NAV – see page 40) of their loans. The average BDC trades at around 93% of NAV with yields close to 10.3%. Most US funds can just about cover their dividends from cash, while some juice up returns using debt to leverage income.
By contrast, UK alternative-finance platforms mostly trade at a premium to NAV with much lower dividend yields. I think that, as platform funds take off, we’ll see our own BDC niche emerge and yields approach the 10% on offer in the US. That could potentially make them a great addition to a portfolio, but there will be risks. For BDC investors, the danger is the fund’s managers shift the loan books towards lower-quality assets in an attempt to maintain underlying yields, notes Gary Chodes, who runs a US-based alt-fi platform called Raiseworks. This means investing more in loans that are further down the capital structure or to smaller and less established businesses. I think the same warnings may turn out to be very relevant for UK investors in alternative-finance funds.