For some time we have been saving and investing in less stock than we should and there are a variety of reasons for this. Certainly the last economic downturn was an important contributor, but investment levels have been declining over the last 40 years or so though with some significant rallies.
This is true in both the US and Europe as a whole where investment has failed to maintain pace with the economic recovery since 2007. For instance, by 2014 Q2 both GDP and consumption in Europe had returned to 2007 levels, private investment was still 15% of the levels in 2007 overall and much less in some countries.
The reason is attributed by many analysts and fund managers to low levels of investor confidence exacerbated by low levels of finance.
While confidence in conventional investments has declined, spurred on to some extent by the banking crisis and other factors, the rise in the popularity of alternative investments has continued to gain momentum.
In the UK alone during 2014 £1.74 billion was invested in non-traditional products and this is on course to exceed £4 billion in 2015. Across Europe it is anticipated to exceed €7 billion and in the US the largest P2P sites Prosper and Lending Club loaned over $5.3 billion in 2014 which is likely to double in 2015.
Here we take a look at the alternative investment market with the primary focus on P2P lending, which currently is dominating the sector with lending to businesses being the leader followed closely by private P2P lending.
While P2P lending sites offer many advantages compared with more traditional financing models, there are also some downsides which we review. An alternative approach receiving increasing attention is bitcoin P2P lending.
We look at this in some detail and show how this platform can provide a better option for investors who are looking for higher returns at the cost of accepting higher risk.
Alternative investments form a broad church. The amount of financing provided to organisations and individuals through these channels has been doubling year on year for several years; in 2014 it achieved £1.74 billion and could exceed £4 billion this year.
For investors it provides new investment opportunities with improved control of their investments.
The main platforms are outlined below and their sizes and rates of growth are shown in the chart below:
- P2P Business lending – mainly between individuals and businesses, mostly SMEs.
- P2P Personal lending – usually un-secured personal loans via websites with
- Invoice trading – selling invoices to investors at a discount in exchange for instant funding
- Crowd funding based on equity – early investors are offered equity, generally for start-ups and early stage businesses
- Crowd funding based on rewards – investors are offered early access to the product/technology
- Community shares – investing in community projects
- Pension fund investments – directors can invest accumulated pension funds in their own business
- Debt securities – long term un-secured loans made by individuals to businesses
- Charity crowd funding – donations with no financial returns
Clearly the two P2P platforms dominate the current stage, and these will be our main focus.
P2P lending is aimed at people who wish to earn more on their savings and investments than that would receive through the banks and other financial institutions and who are willing to accept higher levels of risk and at individuals and businesses that are seeking to access finance that would be difficult and expensive through conventional channels.
Today there is a wide range of P2P lending sites each with their own specific features, but they all share the overall aim of matching up investors who wish to lend with borrowers who need access to cash for consumer purchases or business investment.
- Investors enjoy better interest rates than they would through conventional channels though there is a higher risk of default and although P2P lending is regulated, lenders aren’t covered by the Financial Services Compensation Scheme, so they must shoulder all the risk.
- Borrowers who have found it difficult to obtain finance elsewhere can access funds at reasonable rates as the fees are considerably less than those charged by banks.
In the UK, around a third of business borrowers considered that P2P finance was their only access to funds as they were unable to obtain them from conventional lenders. Of businesses that did obtain finance this way, nearly two thirds showed a growth in profits and over half an increase in employment.
Over half of personal borrowers were able to have obtained loans elsewhere, but chose the P2P route for other reasons, for instance lower interest rates. Nearly half of them used the loan to purchase a car.
There is a wide diversity of P2P investors in terms of how much they invest. While many invest relatively small sums of money of just a few hundred pounds, others invest over £100,000. The average business investments are between £1,000 and £5,000 while the average loans to individuals are £5,000 to £20,000. The chart below shows the percentages of loans to both businesses and individuals by value.
Profits and costs – what to expect
While it is difficult to generalise as different P2P sites operate differently, rates vary, and so do risks, typically a borrower will pay around 13% interest and an investor will receive a return of around 8% after paying fees of around 1% and allowing 4% to cover annual defaults.
The major players
While today there are many P2P sites, some of the more prominent ones include:
- Prosper – founded in 2006 is the oldest US P2P lending site and so far in 2015 has provided over $3 billion in loans. Interest rates are currently 6.6% to 35.9% and investors can expect to make 5% to 9%.
- Lending Club – is the largest P2P lending platform. Founded in 2007, by 2014 it had lent over $7.6 billion to individuals and small businesses. Interest rates are determined by credit risk and volatility range from a little above the base rate of 5.05% up to 25% and higher. Lending club attempts to recover defaulted loans and charges the investor a percentage of the amount recovered.
- ZOPA – this has been running the longest. Established in 2005, it now covers default risks though a Safeguard fund, however this is fairly expensive so investors receive 3.8% for three years and 5% for five years. Loans consist of £10 microloans from multiple investors.
- Ratesetter – This is similar to ZOPA except that there are more ways to customise your investment. You can choose interest rates of 4.8%, 5% and 5.2% depending on how quickly you wish your money to be lent. It mitigates risk through the Provision Fund which currently holds over £14 million.
- Funding Circle – this lends mainly to businesses. Investors can choose which businesses to lend to or alternatively spread the investment across many borrowers using a bidding system and selecting your targeted interest rate. Typically investors can expect to receive 6% or more.
The downsides of alternative investments
While P2P sites have many pros compared with conventional with conventional finance, there are also several cons.
Risk – the more you want to earn, the greater risk you will need to take. Note that your investment isn’t covered by the Financial Services Compensation Scheme which guarantees up to £85,000 invested in an institution such as a building society.
Lock-in – it is likely that you will need to invest your funds for a minimum period of one year and you will be charged if you want to cash out early.
Fees – this could be both a pro and a con. Many P2P sites charge investors a fee on what they lend, but the fee is no more than 1%. Some sites don’t charge any fee.
Delays – sometimes you might have to wait several days before your funds are lent out, though you might just have to wait minutes.
Bank account – although you are bypassing some of the normal financial processing, you still need a bank account to use one of these sites. This isn’t the case with bitcoin P2P lending which we look at next.
At the forefront of alternative investments – bitcoin P2P lending
Bitcoin P2P lending offers an alternative model to conventional P2P lending sites. With sites such as Bitbond, it is easy to become an investor and enjoy the many advantages of this exciting and profitable platform.
Today, bitcoins offer a secure and reliable alternative to real currencies with many advantages. They can be exchanged electronically across all international boundaries in just seconds; transfer fees are considerably less and can be under a cent; and they are independent of banks and similar institutions.
In fact you don’t even need a bank account as you are in complete control. You just keep your bitcoins in a digital wallet, and all bitcoin transactions are recorded in a ledger which can be viewed by anyone.
But there are other reasons why bitcoin offers an attractive alternative investment compared with conventional P2P investors; we will consider these in some depth.
Global portfolio diversification
There is a direct correlation between debt default rates and economic growth as was clearly demonstrated during the 2009 recession when default rates on secured and unsecured loans spiralled and have only recently fallen to pre-2007 levels.
However, even when the developed world was seeing negative growth, in 2009 emerging market economies were enjoying economic growth of around 2.3% with the expectation of concomitantly lower default rates.
Thus by diversifying your portfolio over various regions you are able to reduce your exposure to business cycles within specific markets and enjoy greater stability of your returns. Take advantage of the possibilities afforded by alternative investments in this regard, especially p2p bitcoin lending.
Access higher interest rates
There is considerable variation in interest rates amongst countries. The 2014 real interest rate (the average interest rate adjusted for inflation) for selected countries is shown in the chart below.
The variation is huge, and it is clear that there are some exciting investment opportunities in several rapidly growing economies which have surprisingly high interest rates.
As borrowers in those countries are accustomed to high interest rates from their banks, they are happy to pay considerably higher interest rates on bitcoin loans than borrowers in the UK and the US; they are still paying less than they would with a local bank.
Source: World Bank
The only realistic way to take advantage of these opportunities is with alternative investments, and specifically, P2P bitcoin lending. Currently interest rates are based on the default risk of the borrower rather than their local rates though in the future it is likely that a more granular approach to lending in these high interest rate zones will be developed.
Even without leveraging regional variations, overall returns are typically higher with bitcoin than are available from conventional P2P lending. A comparison of typical ROI achieved across the two platforms shows that conventional P2P yields from around 5.4% to 10.8% while bitcoin lending yields from 10% to 13%.
The fee structure of bitcoin P2P lending is far more advantageous to investors than the conventional P2P model. In the latter case, payments are transacted by banks which charge significant fees for the service while bitcoin lending doesn’t require a bank.
This means that bitcoin lending platforms are able to pass on these savings to their customers to the benefit of their lenders and borrowers.
This is illustrated in the table below which compares fees charged by conventional P2P landing platforms with those charged by Bitbond.
Bitcoins are far more volatile than most conventional currencies, so there is the potential danger that either lender or borrower could lose out on currency fluctuations. However that problem has been addressed.
By tying the loan to the base rate of a currency such as the US dollar, the value of repayments is maintained constant in dollar terms.
To maintain the repayment value the bitcoin payments fluctuate; in other words when the value of the bitcoin falls against the dollar more bitcoins are repaid to maintain the dollar value, and vice versa. Thus both lender and borrower are protected and can profit from alternative investments.
Credit scoring and handling defaults
Another challenge to alternative investments and bitcoin P2P sites is credit scoring. Without the usual credit agencies how is it possible to assess the creditworthiness of a potential borrower?
While it is easy to establish the identity of the borrower and to back this up with information such as proof of income, this remains a higher risk area than on conventional P2P lending sites.
Thus bitcoin P2P loans are more likely to be defaulted than conventional P2P loans; collecting the debt is also more difficult with most alternative investments.
While borrowers who do default on their loans will destroy their reputation and will be unable to borrow on any similar platform, the only final recourse is for the lender to pursue the debt through the courts. This has been done successfully.
As we have shown, the increased risk of default is mitigated by higher interest rates, with different platforms adopting different approaches. While Bitbond bases the interest rate on the creditworthiness of the borrower, other platforms might use a Dutch auction model where lenders bid against each other for the loan.
The bottom line is that borrowers enjoy a lower interest rate than they would receive otherwise, and lenders make a good return.
P2P bitcoin lending sites such as Bitbond are completely transparent in that they publish the complete history of the loan and repayment transactions that occur. This provides any investor with access to all the data needed to make a complete analysis and risk assessment of their intended investment.
Alternative investments and specifically, bitcoin P2P lending offer a huge range of benefits compared with conventional investments and other P2P platforms. The costs are low, there are no international boundaries and you can lend to anywhere in the world, all that is needed is a connection to the internet; you don’t even need a bank account.
Returns are potentially much higher than any conventional investment, and although risks are higher, there are several ways in which these can be mitigated. You can also test the waters before committing significant sums as you can start by investing small sums.
P2P bitcoin lending is still in its early days, but it has already proven itself to be a robust and highly profitable model that should form a part of any investor’s portfolio. The technology is improving continually, as are the mechanisms for mitigating risk and debt recovery, making it the most worth-while alternative investments around.