Imagine an asset class where investor returns have been overwhelmingly positive every year since its inception and incredibly stable, hovering around the mid-single digits, without the rollercoaster of the stock market.
Imagine that this industry was born of an older one, previously closed to retail investors, that had provided proven, stable returns to institutions for many decades, even during the great recession, and other crashes and blips.
Then imagine that a casual comment from the Financial Conduct Authority calls investments in that industry “high-risk”.
This actually happened just a few weeks ago, when the FCA emphasised the difference between cash Isas and Innovative Finance Isas by referring to the latter as “generally high-risk” in a short comment.
To many risk-averse individuals with savings, any amount of risk above bank savings is going to feel like high.
The statement might have had in mind some specific types of higher-risk, higher-reward lending offered by some niche platforms, although the same could be said of ‘adventurous’ unit trusts and open-ended investment companies, or many DIY share portfolios.
It is not unhealthy to have sub-sectors of an asset class that go up the risk scale.
Perhaps instead the FCA comment was referring to investor understanding of basic steps to reduce risk, none of which are new to the realm of investing strategy.
Most importantly, it means diversification because not all lending is equal, not all platforms are equally good at what they do, and investors do not benefit from identical portfolios and returns.
It could simply be the FCA recognises the wrapper of an Ifisa is not conducive to encouraging diversification without additional communication, because some non-advised investors might open one Ifisa and put all their lending capital into it, rather than spread across other wrappers and non-wrapped investment accounts.
And it never does to put all your money in one basket, whatever you are investing in.
At 4th Way, we conduct stress tests of P2P lending loan books based upon the Basel method that banks around the globe are required to use.
We are much tougher though: we test to a one-in-100-year recession instead of a one-in-20-year recession, we assume a property crash leading to a drop of 55 per cent property prices in a distressed sale, and we assume that all loans that are late will go bad on top.
Our analysis finds that the statistical probability of an investor making a loss by the time their loans are repaid by the borrowers is low when they lend mostly at underwritten interest rates across many 4th Way-rated Ifisa accounts.
The stock market is a remarkably good place to invest a large proportion of money for most investors, yet in contrast to diversified P2P lending it can easily plummet 20 per cent in a year for the average diversified stock investor, with share investors who suffer below average returns doing considerably worse.