Investors in alternative finance market should expect to see strong performance and growth from the P2P lending space in the coming years, according to FE Alpha Manager Neil Woodford (pictured). 
The manager of the £8bn CF Woodford Equity Income fund and the £800m Woodford Patient Capital investment trust is one the highest profile backers of the rapidly expanding Peer to Peer (P2P) lending market.
This is where consumers make loans to businesses, individuals and other institutions via online platforms in return for a traditional repayment pattern found in regular fixed income markets with yields of 6-10 per cent often touted as the norm.
However, the capital structure does not apply with P2P loans nor is there a secondary market – two profound differences between regular fixed income and this quickly growing form of finance.
While the size of the P2P balance sheet has doubled every year for five years to nearly £5bn, the largest vehicle available to UK investors to access the P2P market - the £990m P2P Global Investments trust - has been somewhat disappointing since launching nearly two years ago.
According to FE Analytics, it rose rapidly to a premium of 19 per cent in the first months after launch but today has lost 5.05 per cent compared to a 13.32 per cent rise in the IBOXX Markit Overall index, a proxy for the broader ‘regular’ fixed income market.
Performance of trust versus index since launch
Source: FE Analytics
Woodford, however, who chooses this trust for exposure to the P2P market, believes the broader space could soon become a huge growth area for investors.
“It could get massive. The total loans in the UK is about £3trn, but it is not even discernible in terms of the scale of bank balance sheets. They [P2P lenders] could become massively bigger than they are now and still not really capture a significant share of the total loan market,” he said
“It is a very interesting area. I think it is disruptive and there would be no need if banks were doing a good job but the fact is they are not.”
“Banks are dysfunctional and these financing models have grown because there is a gap that needs to be filled. I see them growing it in importance in how businesses get finance in the future. Both equity and debt.”
Monica Tepes (pictured), analyst at Cantor Fitzgerald, says the sector has been hit by a broader de-rating in markets that has seen many trusts hit with widening discounts alongside less bullish press coverage. 
“The P2P investment trust sector lost its premium rating in Q4 last year and currently trades on single digits discounts. However, this is not surprising given that most investment trusts, across most asset classes, have experienced deratings in recent months,” she said.
“There has also been bad press surrounding the peer-to-peer lending business model, which has certainly not helped. However, it is important to differentiate between platforms - there are good platforms and not so good platforms and the trust managers should be well equipped to identify which one is which – but also, very importantly, between holding equity in a platform (the trusts have very little exposure) and holding debt originated by, platforms which is what the trusts do.”
“So far the net asset values [NAVs] of the trusts have been ticking up every month and default rates appear to be within the managers’ estimates. What is less clear is what the sensitivity of the portfolios’ returns is to changes in default/loss rates, especially as the managers also employ gearing – if trusts were to start disclosing such information, that would be a great development.”
Performance of trust versus index in 2016
Source: FE Analytics
Another FE Alpha Manager Mark Barnett (pictured), who is head of UK equities at Invesco Perpetual (the position held by Woodford at the same firm until two years ago), is another backer of P2P and also uses the trust as his vehicle for exposure to the market. 
“Perhaps the most innovative development [in finance] has come from the growth of peer-to-peer (P2P) lending platforms, where entities are not subject to banking regulation, yet are in a position to offer similar products to that of banks, with lower overheads,” he said at the start of 2016.
“P2P lenders argue that their credit scoring technology is as good as the banks’, if not more granular, while their turnaround of business is much faster. Because they do not need to hold regulatory capital or liquid assets, operate physical branches or deal with outdated legacy IT systems, their costs of making and administering small short-term loans are much lower than for banks.”
Not all are so bullish on the P2P sector though. Lord Adair Turner, former chairman of the UK financial services regulator, recently blasted the sector saying it could responsible for “big losses” making regular bankers former faults look tiny.
Woodford disagrees with Lord Turner, though.
“I’m not saying they won’t occasionally catch a crab but they undertake rigorous due diligence. And they don’t need take much of the market to grow enormously.”
“They will deliver low double digit to high single digits,” he added.
Woodford says this will however depend on time, capital and the pace of deployment but he has been adding to his holdings in the recent sell off.
Ben Conway, co-manager of the PFS Hawksmoor Distribution, says he is tempted but thinks the sector is too volatile and uncertain at present.
“We are deciding to remain on the sidelines for the time being. The main reason being that we want to watch them be tested through a default cycle.”
“It is a new asset class that is clearly providing a need that exists [partly due to the retrenchment on banks in recent years) but lending standards will surely vary quite vary across the industry and the quality of each fund will only be revealed during testing conditions.”
“We have an inclination for the vehicles we suspect will fair best (generally those that take an active role in selecting to whom money is lent to - rather than a more passive approach) but for now we’d rather keep our powder dry.”
He also says the rapid growth in offerings in the investment trust space, while interesting, are somewhat alarming.
“The investment trust market rose out of nowhere to over £1bn in assets in under two years. That’s incredible growth in a very short space of time – a degree of scepticism is only natural. Finally, we have asked ourselves do we need to get involved. Currently the returns involved aren’t sufficient enough to make us feel we do.”
Financial advisers also seem not so keen to recommend P2P investment to their clients. Just one in eight financial advisers is willing to invest their own money in the soon to be launched Innovative Finance Individual Savings Account (ISA), which allows P2P investments to be including in the tax wrapper, according to research from MetLife.
The study found 12 per cent of advisers say they will invest their own cash in P2P ISAs when they are launched in the new tax year. Some 31 per cent of advisers are also worried clients will use P2P ISAs for retirement saving because they are attracted by potentially higher returns without necessarily understanding the risks involved.
However, separate research also by MetLife also shows 16 per cent of over-55s are considering using P2P ISAs for their retirement planning.
Simon Massey, Wealth Management Director at MetLife UK said: “The P2P sector is growing strongly and offering attractive returns particularly when interest rates are at an all-time low and likely to remain there which could put pressure on cash ISA savers to find alternative investments.
“However it is striking that financial advisers are not joining the rush to invest in P2P and are generally cautious about investing their own cash in P2P which does carry risks.”
“People need to be fully aware of the possible risks and costs involved in Innovative Finance ISAs and weigh up the risks particularly when they are looking for more certainty over retirement income and investments.”
“Research among over-55s shows worries about ISA investments are not confined to P2P – 46% of over-55s say they are put off stocks and shares ISAs by the risk of savings losing value in stock market slumps.”
