It’s rare for the adviser community to mention ‘P2P lending’, ‘crowdfunding’ or indeed ‘alternative finance’ as viable investment options for client portfolios.
This may appear unusual, considering how much coverage the industry has received in the media, especially since the launch of the Innovative Finance ISA (IFISA).
One might argue that the sector is rapidly gaining mainstream adoption, and the transaction volumes certainly reflect that.
Furthermore, the new IFISA has opened up a range of possibilities. By circumventing the bureaucratic traditional banking system and using technology to directly match those with excess capital to those who require it, P2P and crowdfunding platforms can offer investors high annual returns.
At the same time, they can mitigate risks to relatively low levels, presenting investors with a attractive risk-adjusted return proposition.
Not all alternative finance investments are created equal.According to AltFi Data, the online alternative finance industry in the UK raised around £4bn of debt and equity capital for consumer borrowers and small businesses over the past year – an increase of more than 30 per cent year-on- year.
But even more notable is the fact that of the approximately £10bn of funds cumulatively raised since records began, more than half of that total has come in the last 18 months.
Further tapping into the adviser-led community as a source of capital would undoubtedly be a huge boost for the alternative finance sector.
According to HMRC there is £275bn sitting in cash Isas (earning little to no interest), and Deloitte estimates there is an estimated $1.6trn of wealth managed in the UK overall.
So if advisers were able to shift even a small fraction of the assets under their care into Innovative Finance Isas or crowdfunded bonds, this would move the dial significantly.
Reluctant bedfellows
However, despite visible interest, the financial advisory and wealth management sectors still seem reluctant to embrace this new industry as an investable asset class for their clients. Why?
The feedback we’ve heard from investors is that their IFAs and wealth managers tell them they are not against the concept of P2P or crowdfunding, but that they simply want to see the sector go through a full boom-bust cycle before seriously considering it. Fair enough.
But as the industry matures and fragments, it can be argued that real estate crowdfunding sets itself apart.
In my opinion, the most likely reason for caution around alternative finance is not so much because the industry is entirely new and unknown – it isn’t, it was just the preserve of institutional investors and syndicated/club investors historically – but more because of the lack of security typically associated with the burgeoning sector.
With the unsecured consumer loans offered by many P2P platforms, investors rely on the law of large numbers, diversification, and clever algorithms built on historical data (which IFAs say they lack) in order to minimise risk.
These assumptions, as the events since 2008 have shown, do not necessarily hold true in times of crisis, when you need them most.
On the other hand, what most people think of as crowdfunding typically entails a VC/Angel-type risk profile, backing asset-light companies with little more than a bright idea and motivated founders, but no clear exit in place.
Finding the middle ground
This is why IFAs and wealth managers should start taking real estate crowdfunding seriously; because not all alternative finance investments are created equal.
Crowdfunded real estate-backed debt investments can enable clients to target the same high rates of return offered by P2P lending (beating savings accounts or cash Isas), while further benefiting from the security of a tangible, valuable underlying asset (a differentiator from your typical crowdfunding investment, or stocks and shares).
Clients are also far more likely to appreciate, and be comfortable with, this type of crowdfunding because the underlying collateral (real estate) and its risk characteristics (valuations, LTVs, etc.) are things we are all intimately involved with and intuitively understand.
As investors grow increasingly savvy, and industry regulations and consumer habits change, financial professionals will come under more pressure to justify the fees being charged.
IFAs and wealth managers will need to find new ways to improve risk-adjusted portfolio returns and differentiate themselves from their benchmark-hugging rivals. Real estate crowdfunding could be just the solution.
Charles Tan is co-founder of Global Alternatives
