P2P lending and direct lending is an increasingly popular asset class. Here are three tips to help you achieve a good return from this asset class.
Context: P2P Lending returns can be improved by minimising downside investment risks
Investing in P2P loans is different to other forms of investing such as investing in shares. P2P lending doesn't offer the same upside potential as investing in shares; so to generate the best returns in P2P lending it is important to minimise any downside exposure in your portfolio.
Downside occurs after a P2P loan goes into default and the borrower either can't repay the full amount borrowed, or there isn't sufficient security to cover the amount borrowed. This results in an investment loss
The three tips for successful P2P Lending
Here are three tips to help to target the best returns from P2P Lending by minimising the likelihood and impact of investment losses across a P2P lending portfolio:
- Platform and investment selection
- Asset-backed lending
1. Platform and investment Selection
It is important to undertake a detailed review of each P2P Platform before lending, to ensure they have robust credit processes and can provide loans and receivables that are suitable. The BondMason team has met with 80+ direct lending institutions and conduct detailed due diligence on each, prior to approving or making available corresponding seller's loans and/or receivables.
Good P2P debt investment selection is one of the hardest things to do. There are many different forms of loans and debt types to consider. The team at BondMason has successfully invested £2bn+ over 50+ years of investing - we review all receivables prior to allowing them to be bought or sold through the BondMason system.
We spend hours and hours every day searching, sourcing and selecting the best loan providers, and are often able to access opportunities that aren't normally available to all investors - all for the benefit of the clients of BondMason.
Beating the market isn't always possible, and an important secondary objective should be to do no worse than the market in terms of investment losses. Diversification enables this.
Clients can quickly and easily create a portfolio of 50+ receivables through BondMason. This helps to ensure that if an underlying loan goes bad, then the maximum impact on a portfolio of 50+ loans will be less than 2.0%. Further diversification can reduce the negative impact of a single loan even further.
For example, if you have invested £10,000 across 50 P2P loans, and 1 loan goes bad, then you may lose up to £200. However, if you invest £10,000 across 10 P2P loans, and 1 goes bad, then you could loose up to £1,000. In both cases, your interest rate is likely to be similar; so your total return will be much lower if you just have a portfolio of 10 investments, than if you have a portfolio of 50+ investments.
3. Asset-backed lending
So what happens if a loan goes bad?
If a loan goes bad, then if it is secured against an asset or company; the asset can be sold to recover the amount borrowed. However, if the loan is unsecured then there is often very little the lender can do to recover money from the borrower - and the process of recovery may be much longer, more costly, and less likely to result in a good outcome
It is better to focus toward asset-backed lending, and in particular, assets which have a clear and readily realisable value. This means that if a loan goes bad; then most of the value of the loan can be recovered, and in some cases all of the loan value. This helps to minimise the loss in event of default
For example, a P2P borrower may borrow £10,000, and secure this against a car valued at £20,000. Then if the the borrower is no longer able to repay the loan, the car can be sold; with the proceeds going to the lender (once the loan is fully repaid, the remainder of the proceeds will go back to the borrower).
That's theory, but how's it working in practice
In 2016 all clients of BondMason outperformed the comparative benchmarks, and the average net return was 7.9%:
Extra reading: P2P lending can deliver an attractive return with a low Beta and high Sharpe Ratio
Well diversified P2P Lenders are able to achieve consistent expected outcomes (in technical terms this is known as having a low Beta). When considered alongside the returns that are available, this can lead to a better return with comparatively lower risk - in finance terms this is known as a high Sharpe Ratio.
Warning: nothing on this page or in the BondMason website should be construed as advice. P2P Lending may put your capital at risk. You should speak to a financial adviser to determine if this asset class is suitable for you. Please see full T&Cs and Disclaimer.