Industry powerhouses Invesco, Woodford, M&G, Aviva and AXA are among those turning to peer-to-peer lending for alternative streams of income, according to industry experts.
Income has become a hot topic over the past few years, with government bonds having become more expensive and low interest rates forcing savers to look for new vehicles for their cash.
Indeed, over the past 18 months, UK gilts have performed particularly strongly, returning 8.59 per cent - though this has fallen back from highs in August 2016 where the index was up 17.23 per cent.
In fact, if not for a strong run for UK equities at the start of the year, gilts would still be outperforming the FTSE 100, which has returned 14.51 per cent over the period.
Performance of indices over 2yrs
Source: FE Analytics
The hunt for yield has become increasingly important for large swathes of investors in recent years as the low rate environment has forced them into other risky income areas.
Companies paying an attractive dividend have risen on the back of high demand from investors. Metrics such as earnings potential and growing dividends have been valued higher than ever before.
However, with a number of firms cutting or scrapping dividends in recent years, the number of opportunities to choose from has drastically reduced.
Despite this, many remain unconvinced of using alternative sources of income, choosing instead to stick to the lower returns of asset classes they know.
But this could lead to them missing out on some strong returns and below FE Trustnet look at one area in particular that has taken-off of late – peer-to-peer (P2P) lending.
Steven Lee, chief investment officer of MW Eaglewood, manager of the closed-end fund P2P Global Investments, said he first came across the P2P platforms as a banker around four years ago.
Back then just four platforms existed, he said, now there are 22.
“I met them and I was fascinated by their low cost business model. They were bringing a value added service and disintermediating a high cost industry – a traditional banking industry,” he said.
“Just like eBay, Amazon and other businesses have done to other industries platforms were offering consumers [something different] - attractive borrowing without the cost base of a bank which were making those loans sometimes expensive.”
He says what also makes the proposition attractive is the change in regulatory environment after the financial crisis in 2008, when provisions were put in place to allow non-bank lending platforms as a diversification from the four main banks.
“It wasn’t good to have your country’s entire finance based around four banks so they changed the regulations to allow other people to lend who weren’t called banks, didn’t have a balance sheet and most importantly didn’t have depositors – they had investors,” Lee said.
The CIO says that now the trend has “caught fire globally” particularly in the small and medium-sized enterprise (SME) lending space.
“When you think about it makes sense. On a £100m loan the banking and regulatory costs and the retail branch costs are very small but when you’re lending £10,000 to a consumer or £50,000 to a small SME it makes a massive difference,” he said.
“And by reducing the cost we can bring some really attractive borrowing opportunities to borrowers and also some investment opportunities.
“What marketplace and peer-to-peer platforms are beginning to enable is to offer investors to lend into specific sectors of the lending environment that retail banks used to monopolise and dominate.”
The industry brings a stable pool of capital to an industry that craves that stability of capital as knowing that the lender is there enables a much more attractive and reliable borrowing rhetoric, he adds.
His company runs the £682m P2P Global Investments PLC trust, which buys higher-quality loans (grade A, B and C) from the platform providers from across the market cap spectrum, though it currently focuses on the developed markets only.
Since its launch in 2014, the fund has grown its dividend in each year and currently pays out 5.48 per cent.
Over its lifetime, had an investors paid in £10,000 on the day of its launch, the trust would have paid £1,158, according to FE Analytics.
P2P Global Investments dividend history in income earned since launch
Source: FE Analytics *Figures based on a £10,000 investment in at trust launch
The weighted average life of the loans in the trust is short, says Lee, at around three years, meaning the loan book is constantly “regurgitating” and has the ability to reposition itself.
The trust is on an 18.5 per cent discount to net asset value and has a clean ongoing charges figure of 1.58 per cent including performance fees.
However, one area Lee continues to see investor concern is in delinquencies – or borrowers defaulting on their loans.
He said: “All of the loans amortise so they pay down capital and interest only and typically what that means is at the beginning – if I’ve just lent you £9,000 – you are highly unlikely to default on that loan in the first month because you’ve only just borrowed the money and many of the things that we learnt about you are still true.
“But as time goes on they may become less true – your life carries on. What is also true is that almost no one is likely to default on their loan in the last year when they owe a third of the money they borrowed – they’ll find a way.
“When we do see delinquency – and we do, we expect between 2 and 4 per cent annual delinquency on our fund as a whole – it typically happens in the middle year when the loan becomes mature.”
However, Sachin Patel, chief capital officer at peer-to-peer platform provider Funding Circle says delinquency rates are currently at historic lows.
While the sector will likely be hit by a financial crisis – such as the one seen in 2008 – as borrowers will be more likely to default, he says they are not seeing any signs of stress among their borrowers.
Indeed, with delinquency rates so low, the platform released the SME Income fund at the end of 2015 with the aim of giving investors a passive option to the asset class.
“We had a lot of demand from our largest institutional investors to create a mechanism by which investors can get passive access to small business loans globally,” he said.
“What it effectively does is buy a passive slice of all of our loans across all the geographies that we are in and then we make it available to sell to our investors.”
As it is passive there are no management fees and no performance fees. The fund is on a 2.8 per cent premium to net asset value and yields 5.9 per cent according to the latest data from the AIC.
Performance of fund since launch
Source: FE Analytics
As the above graph shows, the fund has returned 5.7 per cent to investors since launch having initially fallen 11.11 per cent over the first four months.
“It’s been a very stable performer and that something which we are aiming to achieve – something that is almost boring that simply produces a reliable income and allows investors to access this asset class in a very easy low-cost manner,” added Patel.