Despite being only a decade old, peer-to-peer lending (p2p) appears ubiquitous; particularly in the FIRE community. In six years, UK p2p lending has grown from a £200m market to an estimated £7.5bn one in 2018.
With interest rates and the returns on conventional cash investments still below inflation, p2p is an attractive alternative to traditional cash savings.
Since 2016 investors can hold p2p investments in the Innovative Finance ISA (IFISA), offering a further enticement to cash-weary investors.
Today, I’m going to have a look at the UK p2p market. Personally, I don’t have any p2p investments; it’s never something that has felt like it’d work for me. So I won’t be talking about it from a practical experience. If you have dipped your feet (or plunged right in) with p2p lending, do share your experiences in the comments!
History of p2p in the UK
The first p2p lender in the UK was Zopa. Starting up in 2005. Since those heady days, Zopa has been joined by over 80 firms (as well as some others that have been unsuccessful).
In 2014, recognising the rapid growth in the p2p market, George Osborne (then Chancellor) announced that p2p investments would qualify for being held in an Individual Savings Account (ISA). Offering p2p investors the chance to squirrel away their investments in a tax-efficient wrapper.
It took some time for the Innovative Finance ISA (IFISA) to get set up. It wasn’t until April 2016 that IFISAs finally launched. Even then, few platforms offered IFISAs due to regulatory hurdles.
The personal interest allowance also kicked in on 6 April 2016. Basic rate taxpayers could receive £1,000 interest tax-free and higher rate taxpayers up to £500. Somewhat reducing the desirability of putting p2p investments in an ISA wrapper.
But those setbacks haven’t stemmed the flow into p2p investments. Platforms are still struggling to match supply and demand; many platforms still do not offer IFISAs. Only 2,000 IFISA accounts were opened in the 2016/17 tax year, compared to 2.6m stocks and shares ISA subscriptions and 11.7m cash ISA subscriptions.
As mentioned above, there has been rapid growth in both lending volume and the number of platforms. Lending volumes topped £5bn last year; and with a more than four-fold increase in the number of platforms.
Source: Chartered Institute of Securities and Investment (CISI)
Overall, the market is dominated by four big players – Zopa, Funding Circle, RateSetter, MarketInvoice. Together they control over 60% of the total market. Each are market leaders in their own segment.
Zopa is the leading consumer-to-consumer (c2c) platform and has an almost 50% market share in the segment. Funding Circle is the leading lender to SME businesses; last year lending out more than the traditional high street banks. RateSetter distinguishes itself by offers property and asset-backed loans. Finally, MarketInvoice is one of the market-leaders in the rapidly growing invoice-financing sector.
Regulatory authorisation by the FCA has held back the number of IFISA platforms. But over the tail-end of 2017 and the first half of 2018, authorisations have picked up. About 60 platforms are now fully authorised, and over 40 of those are registered with HMRC.
As an investment
The first big thing to remember about p2p investing is that, unlike traditional bank deposits, it’s outside the Financial Services Compensation Scheme (FSCS). That very much means capital is at risk.
p2p investors are open to both default risk (the borrowers default on money lent) and counterparty risk (the platform itself defaults). Also, whilst not specific to p2p lending, there is an element of fraud risk. With some high-profile troubles at US lenders and in other countries.
An issue that personally troubles me (harking back to my days as a forensic accountant) are legal and operational risks. Where the legal ownership of assets or funds is unclear due to poor record keeping; fraud; or operational oversights.
One of the selling-points for p2p lending is that returns are thought to be un-correlated with equity returns. This makes the investments particularly appealing for diversification purposes. One caveat to that is that: “When the $h!t hits the fan all correlations go to one!” (thank you to Karsten at Early Retirement Now for that saying).
However, p2p lending offers the possibility of significantly higher returns than both cash deposits and equity returns. Returns of up to 15% are not unheard of. The variability of returns makes appraising an expected return challenging. A number of FIRE bloggers have been carefully documenting their returns over the years (among others, Retirement Investing Today with RateSetter and FoxyMonkey with a number of platforms).
One particular criticism is that p2p investors are enticed to invest by the promise of an unrealistically high rate of return. At the moment, we have only a short period over which to assess return claims and have yet to (arguably) go through a full market cycle. This is an area that the FCA are keeping a particularly keen eye on.
Comparison of platforms
As mentioned above, I don’t have any p2p investments so I’m always on the lookout for platform comparisons. The CISI recently published an excellent (and comprehensive) platform comparison table which I share below:
Factors to consider
As there is such a wide diversity of p2p platforms it is difficult to compare p2p lending as an investment versus other asset classes. With that in mind, investors will need to compare different platforms and products to find ones that are suitable for them.
Some of the factors that investors should consider when investing in p2p lending are:
- Cost: What charges does the platform explicitly AND implicitly levy on investors?
- Robustness of provider: Whilst incredibly difficult to evaluate, it is worth thinking about who are the backers behind the platform?; Is the platform turning a profit (or making huge losses)?; How long a track record does the platform have?; What authorisations, controls and processes does the platform have?
- No. of lenders / no. of borrowers: Are there large numbers of diversified lenders and borrowers? What is supply/demand like on the platform? Is there an abundance of lenders and little demand?
- Diversification and risk-selection: Are loans diversified across a number of borrowers (type, size, sector)? Is it possible to specify what types of loans can be made and to whom?
- Liquidity: How easy is it to get money out of the platform? Does the platform make it difficult to get money out? Can loans be encashed early and at what cost? Is there a secondary market for loans?
- Default: What is the rate of default? (And perhaps more importantly) How is that rate calculated? How does the platform account for and deal with defaults?
Why I don’t invest in p2p
There are three main reasons I don’t invest in p2p (do let me know if there are holes in my thinking):
- Unlike my cash deposits, capital is at risk. In that sense, I’d lump it with my bond and equities investments and not my cash holdings. And given that, I’m quite reluctant to sell those investments to put it into p2p.
- The lack of correlation to other assets is enticing, but one of the first rules of finance I learned was that in market shocks the correlation of assets tends towards 1. We don’t know yet if this will also apply to p2p, so for now, the correlation stats have an asterisk next to them.
- The market is still quite young; there are lots of players out there – it feels like too many. I’d expect there to be some consolidation and some platforms going out of business. Trying to work out which platforms will be the winner seems like too much effort to me – in my ‘too hard pile’. I like my investing to be easy and lazy!
So for now, I’m sitting on the sidelines as a curious spectator.
It’s still early days in the p2p market, but it’s clear that p2p lending is here to stay. The big players and early movers are now establishing a track record. With overall rates of return and default becoming easier to gauge.
However, it’s not all been plain-sailing. With several high-profile problems at some platforms as well as some going out of business. Further, some platforms don’t seem to be sustainable in long-run, racking up huge losses.
p2p investing offers the potential to make higher rates of return than cash deposits and equity investments at apparently low levels of correlation to other assets. But in market crises asset returns tend to all move together, and p2p investing has yet to sail through truly choppy waters.
Please post a comment if you are (or were) a p2p investor. I’d be interested to know your experiences – both good and bad.
[Disclaimer: none of this post should be construed as a recommendation to invest in a particular investment or with a particular platform. This post is for information purposes only. Please do your own research, and speak to an FCA authorised investment adviser if necessary. I won’t take any liability for any decisions you make off the back of this post.]
All the best,
Young FI Guy
[p.s. I’ve just realised Monevator updated his RateSetter post whilst I was on holiday – http://monevator.com/ratesetter-high-interest-offer/]