Over the next few months your clients will be asking you how they can put their Isa money into peer-to-peer lending.
Advisers are rightly cautious about the risks associated with lending directly to borrowers but I am concerned many have misunderstood what those risks actually are.
I’d like to dispel some of the myths associated with P2P, and lift the bonnet on this new asset class, to reveal the opportunity beneath.
P2P lending bypasses the banks using an online platform to assemble syndicates of lenders who each loan money directly to a borrower.
Borrower and lender share what would otherwise be the bank’s profit, and the lender’s risk of default is spread over many individual loans each at a fixed interest rate of their choice.
The lender earns interest (normally between 5 per cent and 15 per cent) less fees charged by the platform and any losses they incur.
Each P2P platform has a different offering ranging from unsecured personal lending through to secured business lending and as an adviser, so it is important to understand the differences.
It is also important not to get P2P lending confused with equity crowdfunding - a very different proposition where the risks are far higher.
The familiar warning that ‘the value of your investment can go down as well as up’ is not appropriate for P2P loans which are made at a fixed-interest rate and provide predictable monthly income ideal for capital draw down.
Variations in financial markets won’t affect their value and that fact alone makes P2P loans worthy of consideration as a way of mitigating exposure to volatility.
Lenders will only lose money if the borrower defaults and this will depend upon how well the platform filters borrowers and recovers debts.
Much is made about the lack of Financial Services Compensation Scheme cover for P2P lending but with no intermediary taking responsibility for the investment decisions it is simply not a safeguard.
It also seems to miss the really radical thing about P2P: that lenders each make their own investment decisions and make loans directly to each borrower.
It is this ‘disintermediation’ that makes P2P so financially rewarding.
FCA regulation means platforms have to make arrangements to manage an orderly run-down of loans in the event of platform failure so that existing loans would still be repaid.
Checking that a platform is a member of the P2P Finance Association is a good first start in your assessment.
The most established platforms have now been operating for over five years and have a track record worth looking at.
Another important factor to consider is liquidity. All of the established platforms operate a secondary market where loans can be traded.
The biggest ‘elephant in the room’ for advisers is that the FCA still classifies P2P loans as ‘non-standard investments’, which currently makes it difficult to recommend them.