When looking for somewhere to invest your hard-earned money, it’s only natural that generating a respectable return will be high on your priority list - something which has been particularly in focus in the last decade or so when many savers have suffered from negligible returns coupled with rising inflation.
Savers and investors are seeking out alternative options such as Direct Lending
Considering the ‘saver unfriendly’ environment we continue to find ourselves in, it is no surprise that the last few years have seen an increasing number of savers and investors seeking out alternative finance options in the hunt for a better return on their cash. Newer asset classes such as Direct lending (which includes Peer-to-Peer lending) have become increasingly mainstream as more investors include them within their portfolios.
Relative to some other asset classes, part of the appeal of direct lending is its attractive returns. High returns can be tempting - after all wouldn’t most of us prefer our money to be working for us rather than sitting idle earning negligible interest (even loosing value in real terms if you bring rising inflation into the equation).
Headline returns may not accurately reflect the quality of an investment
However, many savers still focus exclusively on ‘headline’ returns when considering where to place their money. Whilst expected returns and past performance are important, they can only serve as an indicator; they aren’t a reliable measurement or a guarantee of future performance. Focusing on returns in isolation is unlikely to provide you with enough information to enable you to make an informed decision about the merits of an investment opportunity or operator.
Factor ‘risk’ into any evaluation
Risk is a key factor to consider when you are evaluating how attractive an investment really is. We all have individual risk appetites and need to decide what level of risk we are willing to take to target a desired return. As a rule of thumb the higher the promised level of the return then the higher the level of risk (and more likely than not, if something looks too good to be true then it probably is).
Direct Lending and P2P lending can be an appropriate addition to a diversified portfolio; potentially giving access to significantly higher returns than can be achieved through a savings account. However, if considering investing in Direct Lending it is important to recognise that alongside any benefits, higher returns will mean exposing your money to a wider range of risk factors.
There are a multitude of operators out there – varying considerably in terms of quality. And, unlike many savings accounts, your money is not protected by the FSCS (Financial Services Compensation Scheme).
What other factors should I consider before I commit any money to direct lending?
Although some risks will always be present there are things you can do to mitigate against some of the more ‘avoidable’ risks. For example:
Careful platform selection
There are well over 100 direct lending and P2P operators in the UK, so take the time to fully research a platform before you commit any of your capital. You may find our article ‘Five things to look for in a lending platform’ helpful.
Research the operator’s investment team – how much investment experience do they have? An experienced team will be better able to originate and manage loans, as well as identify loans to steer clear of.
How transparent is the platform with the information they disclose about their investment performance? What are their clients saying about them? What due-diligence checks do they carry out? What is their recovery process? These are just some of the questions you may wish to ask before committing any money.
Diversify, diversify, diversify
Diversification is one of the key ways to minimise the impact of potential losses.
- Diversify your portfolio. Investments can incur losses as well as gains, so it is sensible to have a well-balanced and diversified portfolio of different financial investments. In other words, don’t put all your eggs in one basket.
- Diversify across different lending partners. Spreading your money across more than one direct lending operator will help manage risk further and help protect against the impact of any operational failures.
- Diversify across different loan types. It is difficult to predict how any one loan will perform therefore, spreading your capital across different loan types, durations and grades will help protect your capital. For example, our analysis shows that a loan portfolio of 100+ loans is likely to be better protected from downside risks compared to a portfolio of 50 loans or fewer.
Only invest a sensible proportion of your money
As we previously mentioned, Direct Lending is not protected by the FSCS so it is important to keep in mind that your capital is at risk. As with any investment opportunity only allocate a sensible proportion of your money.
Ultimately how you choose to invest your money should come down to your own financial priorities and your individual risk appetite. Direct lending can form part of a well-balanced and diversified portfolio; however, if you do decide to allocate some of your money into alternative options such as direct lending and P2P lending, then make sure you are not swayed by returns alone - factor risk into any investment decision and ensure you understand and are comfortable with the level of risk you are taking.
*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.