Seeking out decent returns in the current economic environment is becoming increasingly challenging. Inflation is currently 3.0% (noticeably up against the Bank of England target of 2%) and is having a significant impact on the real value of wealth as the cost of living continues to rise.
Indeed, recent research from Rathbones Investment Management notes that many investors now consider rising inflation more of a threat to their finances than the continued uncertainty surrounding Brexit.
With rising inflation, low interest rates (Bank of England base rate is just 0.5%), and Brexit; having a well-balanced, diversified portfolio is one of the most important things you could do to help lessen the impact on your finances. Direct Lending can be an attractive addition to just such a portfolio.
What is Direct Lending?
Direct Lending (which includes peer-to-peer (P2P) lending) has been around for over 10 years in the UK, but it is only in the last few years that we have seen it become more mainstream. Essentially, Direct Lending unites investors with borrowers - usually through an online lending platform.
Because Direct Lending platforms tend to be smaller and nimbler than banks, their operating costs are lower; therefore, investors can potentially benefit from access to higher returns than most banks can offer through cash ISA’s or savings accounts. However, it is important to highlight that unlike high street saving accounts, with Direct Lending your capital is at risk and your money is not protected by the Financial Service Compensation Scheme (FSCS).
The UK Direct Lending market continues to grow steadily; consequently, we’ve seen increasing numbers of investors include direct lending and P2P lending within their portfolios.
Direct Lending – typically lower volatility than stock markets
Image source: Market Report: Direct Lending in the UK
In addition to accessing higher returns than cash ISA’s and savings accounts currently provide*, Direct Lending also tends to be less volatile than the stock market. As an asset class, Direct Lending, inhabits the middle ground between the higher volatility (and generally higher risk) / higher returns of the stock market and the lower volatility (generally lower risk) / lower returns of high street savings accounts and cash ISAs.
Why is volatility a consideration?
In the purely illustrative example below, the overall return figure of Investment A and Investment B over the 12-month period are the same, but the journey each investment takes is very different.
Supposing we needed to liquidate an investment earlier than anticipated – for example in October – then Investment B becomes considerably more attractive. Direct Lending, illustrated by example investment B, occupies this more stable ground (relative to the volatility of the stock market). And, although Direct Lending investments are a term product, a well spread range of underling positions combined with a growing secondary market are providing investors with access to greater levels of liquidity than in the past.
Having a multi-asset portfolio that balances different investment types – some with higher levels of risk (volatility) and some with lower levels of risks (volatility) – can be a sensible approach to get your money working harder for you; potentially lessening the impact the current economic environment may have on your finances.
Understand the pitfalls as well as the benefits
As we’ve discussed, Direct Lending and P2P lending can be a productive addition to a diversified portfolio; however, if you are considering investing in Direct Lending it is important to recognise that alongside the benefits, higher returns will mean exposing your money to a wider range of risk factors*.
Most notably, Direct Lending and P2P is not protected by the Financial Services Compensation Scheme (FSCS). For example, should your lending platform fold you are not eligible for FSCS compensation. Your money is also open to losses. Loans can, and do, default and you may not get back some (or all) of your investment amount.
There are a multitude of operators – varying considerably in terms of quality. Even though recent regulations have meant some lending platforms now have FCA authorisation, it is important to understand that authorisation in itself does not guarantee quality of the platform, your return or protect your money. Therefore, one of the most important considerations is platform selection. Take the time to do your homework and don’t be swayed by headline returns in isolation. You may find our article ‘Five things to look for in a P2P platform’ useful reading.
If you are aiming to beat inflation and lessen the impact of the current economic environment on your finances then it may well be worth considering Direct Lending as part of a diverse, multi-asset and balanced portfolio.
*Warning: nothing in this article should be construed as advice. Your capital is at risk.
BondMason, the UK’s leading Direct Lending specialist, makes it easy for investors to target gross returns of up to 8%+ p.a. by enabling clients to invest in Direct Lending the smart way. Our Senior Investment Team has a wealth of relevant experience – each with over 15 years’ investment experience in financial institutions; including Fidelity, Blackstone, Ares, Lloyds, Babson and JP Morgan.
Through hours of in-depth research, face-to-face meetings, and a robust due diligence process, our experienced investment team only approves a select number of lending partners and P2P platforms to work with. In fact, although we’ve reviewed over 100 potential lending partners, we have only approved 26 to-date.
Download your free guide
To find out more about how to make informed decisions about your lending portfolio, download your free copy of Steps to Successful Investing in Direct Lending.
Steps to Successful Investing outlines 7 key steps you may want to consider if you are thinking about Direct Lending and P2P lending as an addition to your investment portfolio.