One of the few areas to benefit from the 2008 financial crisis was peer-to-peer (P2P) lending, which allows people to bypass the banks with investors able to lend directly to individual borrowers. Cutting out the middleman makes it possible for those with spare cash to earn a higher return and for the borrowers to pay a lower rate of interest.
Those who don’t want to use a P2P platform to choose the loans themselves can still benefit from the high level of income by using one of the investment trusts that operate in this area. These include the likes of Funding Circle, Honeycomb and P2P Global Investments, with the average net yield in the sector being 7.1%.
The investment trusts offer much greater diversification by investing in thousands of different borrowers spread across multiple platforms and geographies. You also benefit from the due diligence of the fund manager in selecting the best loans and don’t have to tie your money up as you can sell your shareholding whenever you want.
There are currently six peer-to-peer investment trusts listed on the London Stock Exchange and between them they have total assets of £1,870m. If you are thinking of investing in this area you would need to be extremely careful as their performance and prospects differ enormously.
One of the most successful has been Funding Circle SME Income (LON:FCIF), which has recently raised £142m via a C share issue. The C shares have just started trading under the ticker FCIC and will convert into Ordinary shares once the proceeds have been substantially invested. This is expected to be within nine months with the C shareholders entitled to receive a single dividend prior to conversion that represents pretty much all of the net income that accrues on the new money.
FCIF raised £150m when it floated on the stock exchange in December 2015 with the capital being invested in a diversified portfolio of small and medium sized enterprise (SME) loans originated through the Funding Circle marketplace. About 80% of the money has been lent in the UK, with 18% in the US and 2% in Continental Europe.
If you are thinking of investing in this area you would need to be extremely careful as the funds’ performance and prospects differ enormously.
At the end of February the fund provided exposure to 3,576 different loans with a weighted average gross yield of 10.5%, and a realised bad debt rate of 2.3% per annum. FCIF is paying quarterly dividends of 1.625p (equivalent to 6.5p a year, which is in line with its target of 6-7p per share) and has a NAV total return target of 8-9% per annum once the money has been fully deployed and the gearing is in place.
The successful C share issue will take the net assets to £306m and is a real endorsement of the fund. Investors appreciate the fact that it only invests in SME loans made via the Funding Circle marketplace and that it has delivered on its target return to date. It is also good value as it only levies a 1% service fee with no annual management charge. The shares are currently trading on a 3.9% premium to NAV and yielding 5.8%.
P2P Global Investments
At the other end of the spectrum is P2P Global Investments (LON:P2P), which is the oldest and largest of these funds with total assets of £914m. It launched in May 2014 and invests in personal loans made through various P2P platforms with the aim of generating a 6% to 8% dividend yield on the original issue price.
For its first 18 months or so the shares traded at a healthy premium, but the fund has failed to meet its return target and has slipped to a 16.3% discount despite having an active share buyback programme to prop up the price. Another problem is the high level of charges with the 1% annual management fee topped up by a 15% performance fee with no hurdle rate.
The poor performance has recently prompted the Board to initiate a review of its investment management arrangements. The firm responsible for this, MW Eaglewood, has responded by saying that it is looking at what additional steps could be taken to improve the results.
P2P Global Investments’ shares responded positively to the news, although they remain well below their original issue price of £10. Assuming that the fund can maintain its current quarterly dividend of 11p the shares offer a prospective yield of 5%.
The rest of the sector
VPC Speciality Lending (LON:VPC) is the second largest fund in the sector with total assets of £356m. It has followed a similar path to P2P Global Investments with the shares sliding from an initial premium to a large discount that currently stands at 19.5%. At 76p they are now more than 20% below their issue price.
The fund has been actively buying back its shares to try to control the discount, but this wasn’t enough to stop one of its largest shareholders, Old Mutual, from selling down its stake. Victory Park Capital Advisors, the investment manager, has been attempting to improve the performance by reducing the number of loans from P2P and marketplace lending platforms, and increasing the balance sheet exposure, which now represents more than half of the portfolio.
Balance sheet loans are made through a special purpose vehicle with the recipient platform using the cash to originate loans. The main benefit of this is that the counterparty risk is with the associated platform rather than the individual borrowers. VPC’s quarterly dividend has been reduced to 1.5p, which gives the shares a prospective yield of almost 8%.
Income investors would struggle to earn these sorts of high yields from more established asset classes.
Another casualty has been the £184m Ranger Direct Lending (LON:RDL) that launched in May 2015. The shares are up about 10% on the issue price, but they are trading on a 14.4% discount to NAV. RDL is targeting a 10% dividend yield once the portfolio is fully invested and the leverage is in place, although it is currently paying less than 3%.
It is a different story for the £197m Honeycomb Investment Trust (LON:HONY). This launched in December 2015 and is aiming for a dividend yield of 8% on the issue price. The fund makes loans to consumers and small businesses and has generated a NAV total return since launch of 9.3%. The shares are trading on a 10.5% premium and offer an historic yield of 6.1%.
Despite the mixed performance this is definitely an area that is worth keeping an eye on as income investors would struggle to earn these sorts of high yields from more established asset classes. The funds are yet to be tested in a recessionary environment when the level of bad debts would be expected to increase, but if the wider market experiences a setback there could well be a decent buying opportunity given that the sector is already largely out of favour.