2015 marked an important year in peer to peer investing. During the year the industry lent over £2.2 billion, which has doubled the amount lent by the main players to a total of £4.4 billion. The number of lenders has increased by a quarter to a little over 128,000 and the number of borrowers has doubled, reaching 273,000.
Given that from April 2016, peer to peer investing in the UK will be given a boost as it will be possible for lenders to wrap their peer-to-peer investments in a Finance ISA and receive tax-free interest, this could be the year when per-to-peer investment really does come of age as a mainstream investment option.
Globally peer to peer investment opportunities are also expanding, particularly in the US, Australia and China. In the US peer to peer lending reached $5.5 billion dollars and by 2025 the global market is expected to reach $150 billion.
Here we take a look at the current status of the market, including the potential effect of the new ISA. We also look at the basics how to invest. Please note that this is for your information only; it shouldn’t be taken as investment advice.
Risks and returns of peer to peer investing
With savers growing increasingly frustrated at the derisory interest rates on savings offered by the financial institutions, growing numbers of investors are turning to alternative investments such as peer to peer investments. There is no argument that the returns on these far outclass those available from savings accounts, but naturally the price is an increased risk of losing capital.
Do the returns compensate for these risks or is peer-to-peer investment an asset class to avoid? The bottom line seems to be that peer-to-peer lending is less risky than it might initially appear and, even through the dark days and nights of the financial crisis, peer-to-peer investors kept their heads above water
What are the risks of peer to peer lending?
Many countries have Deposit Insurance schemes that will protect a proportion of your investment in a range of assets, for instance in the UK the FSCS guarantees the first £75,000, in most of Europe similar schemes protect the first $100,000, and in Canada the first C$100,000 is guaranteed.
The don’t, however, cover peer-to-peer investments, so your capital is at risk, especially if there is another economic downturn. If is when people lose their jobs that default rates tend to rise and your borrowers can no longer afford to repay what they owe.
These are of course theoretical risks, so it is worth looking back at what really happened during the downturn. In fact, the track record of peer-to-peer investment has been good. Even through the financial crisis of 2008, Zopa investors saw no significant loss of capital, and although there was a dip in returns, this was relatively short lived.
One way in which investors are able to manage risk is to spread their investment over a large number of borrowers. While some of these borrowers might hit a difficult patch and find they are unable to repay their loans, it is highly unlikely that this will apply to borrowers in bulk. Of course global events affect everyone, but even then it seems that most peer-to-peer borrowers were able to ride out the storm.
What are the current returns?
In the early days of peer-to-peer investing, Zopa returns to lenders were between 5% and 6% after defaults and fees. Currently this is now 4% for up to three year loans and 5.1% for five year loans. RateSetter currently offers returns 2.6% for one month, 3.5% for one year, 5.5% for three years and 6.1% for five years.
Funding Circle, which concentrates on business loans is offering returns of up to 6.8%, and ThinCats provides a 9% average return with MarketInvoice showing gross annual returns of up to 11%.
In the US peer-to-peer investing returns with Prosper and Lending Club can deliver returns of from around 6% to 11% depending on the level of risk that you are willing to take and similar returns are also available with Bitbond.
Should the banks be worried?
Globally, peer-to-peer investing is serving to plug the gap left by the banks in their reluctance to fund many small business following the financial crisis, so should the banks be concerned regarding potential threat to their core lending business? There is certainly some criticism of peer-to-peer investing from that quarter, which might be viewed as sour grapes.
For instance, Lord Turner, a former UK City regulator, has criticised the sector arguing that automating credit worthiness on a platform cannot replace the traditional credit analysis carried out by the banks, and warning that there will be losses in the future. However, his comments have been dismissed by the Peer-to-Peer Finance Association (PtPFA) who point out that Turner’s views take no account of the industry’s record and that default rates are as low as 2% to 3%.
Naturally the peer-to-peer market is currently far too small to worry the banks, but the main banks are taking note. While currently peer-to-peer lenders are mainly focused on consumer credit and in particular credit consolidation and small business loans, there is plenty of space for expansion in markets such as student loans, car loans and mortgages; areas where the banks could be threatened in the future.
World Perspective on Peer to Peer Investing
Peer to Peer investing is developing globally, and as mentioned in the introduction some of the major markets in which it is making an impact include the UK, USA, China and Australia. For instance:
UK – in the UK peer to peer investing will gain a significant boost from the April 2016 launch of the Innovative Finance ISA (IFISA) that will allow peer-to-peer investors to wrap their investments in an ISA up to the current ISA limit of £15,240. IFISA rules are somewhat different from those of conventional ISAs to allow for the nature of peer-to-peer investments which are less liquid than many other investments.
While currently only around 7% of investors in the UK use peer-to-peer platforms, according to some analysists this is set to soar to 40% following this launch. 2016 may also be the year when institutional investors test the peer-to-peer lending markets for funding small businesses, a move that could more than double the amount of investment on the platforms. Should this happen, then there could be some significant changes to the model.
Already there are indications that the big investors are getting involved. A quarter of peer-to-peer loans are funded by larger investors such as the traditional banks and also the government, for instance through the state owned British Business Bank. In 2015 almost a third of peer-to-peer consumer loans and a quarter or peer-to-peer business loans were institutional investor funded.
USA – Although peer to peer investing in the USA has seen strong growth it appears to be experiencing some setbacks recently. For instance, some states set interest rate caps which can impact on some loans, and there are suggestions that the Consumer Financial Protection Bureau (CFPB) could be further regulating the industry. There also seems to have been a rise in delinquencies over recent months, though these are probably a result of the current state of the economy.
China – peer to peer investing is gaining general acceptance in China where there are now several thousand local peer-to-peer lending platforms. Not all of these operate exclusively online – some have a physical presence and provide fact to face loans. The current peer to peer investment market in China was around $35 billion in 2014 and China News has reported that in 2015 this grew to $150 billion, though this could be an over-estimate. Peer to peer lending regulations are being introduced by the Chinese government.
Australia – Peer to peer investing in Australia reached $500 million during 2014 and already Australia’s four big banks are taking note. The leading platforms are SocietyOne, the Australian version of RateSetter and the recently launched Melbourne based MoneyPlace, which is 20% owned by Auswide Bank which invested $60 million in the startup.
Impact of Peer to Peer Bitcoin Platforms
Bitcoin is becoming progressively more acceptable generally, and already is having a significant effect on banking. Thus it is no surprise that many peer to peer investors are enjoying considerable successes investing in platforms such as Bitbond.
Compared to currency based platforms, peer to peer bitcoin platforms provide several advantages such as: access to international markets with more opportunities for diversification; access to higher interest rates; and, as banks are not involved, considerably lower fees. In fact, with Bitbond double digit returns can be readily obtained.
Peer-to-peer investing isn’t for everyone, however, many who do incorporate it into their portfolio are seeing handsome returns with little or no downside. Globally there are indications that the market is rapidly expanding, and even some main banks are getting in on the act.
Peer to peer bitcoin investment is also impacting on the market and as the market grows, peer-to-peer investment will continue to evolve, though perhaps this is the optimum time to sample what it has to offer.