How to find the right platform

But according to Dr Mark Davis at the University of Leeds, a large part of it is to do with setting aside a small portion of one’s portfolio, to invest in something ethical or to have a punt on something more adventurous.

An economic sociologist, he conducted a research exercise with the Financial Conduct Authority (FCA) looking at why people invest through these platforms.

He says: "It really is a challenge to conventional investor behaviour, where all that matters is maximum value in terms of financial return.

"A lot of investors we spoke to had a well-diversified portfolio, with 80 per cent to 90 per cent of their funds in standard products, and that's where they expected to get their financial returns.

"The remaining 9 per cent or 10 per cent they had earmarked for more social outcomes. It might get you a good financial return or it might not."

You also need to look at its lending history - how long it has been running, what does its early loan book look like?Alan Sheehan

He continues: “We spoke to people who wanted to support business sectors they've worked in previously, or who invested in specialist regions, such as Yorkshire or East Anglia.

" A lot of people approached it with a different set of motivations and perception of risk; there was a tendency to take a chance on a crowdfunding investment because of the broad social and environmental goals."

Many peer-to-peer (P2P) and crowdfunding platforms will make it clear what you are investing in, especially if the loan or debt product is for a business, and these can be, for example, investing in a wind farm, or helping to support a local community project.

But a lot of the P2P lending platforms are much less clear about who investors are lending to, transferring your funds into a portfolio of borrowers who fit a risk profile, and of whom you might not know their identity.

Making the right choice

So how does an investor go about selecting the right platform, and choosing the most appropriate investment?

Alan Sheehan, a technical manager at in:review, which provides technical support to advisers at network In Partnership, whose clients want to use one of these platforms, says the most important thing is to do due diligence on the platform.

For a start, when deciding on whether to opt for P2P lending and equity crowdfunding, the former is far more liquid than the latter. Mr Sheehan says: "With equity crowdfunding you're buying shares in a private company, and you will not be able to sell those shares.

"They are not a listed company. You will be looking for an exit, only when that company is bought by a larger competitor. It's a long-term investment."

When deciding on which P2P platform to invest in, Mr Sheehan says it is important to look at the financial performance of the platform.

"You also need to look at its lending history - how long it has been running, what does its early loan book look like?"

A good place to start is the P2P Finance Association, found at p2pfa.org.uk, which has eight members, all of whom have committed to signing up to the organisation's operating principles. This includes managing their business with technical and professional competence.

Mr Sheehan says: "Being a member means they will publish loan data, and do it in a prescribed format. They will often publish their default rates and loan payment rates." 

Not every platform is a member of this organisation, so it is a factor to look out for.

The website for the UK Crowdfunding Association is ukcfa.org.uk, where members are also required to adhere to a code of conduct.

Layer of security

Another pointer is whether the platform has a provision fund; this helps cover lenders if their borrower defaults.

Mr Sheehan says: “The platforms build the provision fund into the pricing. If they say you will get 4 per cent, you’ll pay 4 per cent, and will be charging the borrower more, and that will be put into the provision fund.

“It’s a good thing, as it can provide an extra layer of security.” 

However, Dr Davis found that not every investor was happy about this. He says: “The more sophisticated investor resents it hugely, because they don’t think they would make the mistake [of investing in a borrower that defaults].”

Many investors gather information about platforms from online forums or industry events, says Dr Davis: “There’s a huge number of these platforms where the level of security or transparency isn’t what it could be.”

For example, one investor wanted to invest in a wind farm due to a personal commitment to renewable energy.

Dr Davis says: “They thought they were investing in a wind farm but they were investing in a securitised debt product that had already paid for the wind farm, and they were paying off the loan.”

P2P loans can be put into an Isa, as can debt-based crowdfunding investments, but not equity investments. Many platform operators offer an Isa, but they have to be registered with HM Revenue & Customs.

Many Sipp and Ssas operators will allow crowdfunding bonds and debentures, as well as equity investments, but generally not P2P loans.

melanie.tringham@ft.com