Peer-to-peer (P2P) lending is a form of crowdfunding, a method of raising capital that is nowadays often facilitated via the internet. Rather than rely on large amounts of funding from a handful of entities, crowdfunding uses small investments from a large pool of individuals.
For example, in traditional investing, an entity such as a venture capital (VC) firm might invest $5 million into a company and acquire shares in it. This places significant risk on the VC firm, and requires the company to surrender a portion of ownership or control.
Using a crowdfunding platform, however, 5,000 individuals might each invest $1,000 into the company. Each of those individual investors is exposed to a very small amount of risk, and the company is able to raise the funds without surrendering ownership.
Depending on the P2P lending platform and the type of financing it provides, individual investors are able to lend money to companies with small minimum sums. These short-term loans are repaid with interest that exceeds what they could get from a bank deposit interest.
P2P lending for accredited investors, versus retail investors
P2P lending platforms in Singapore are of two stripes: the first group is open to retail investors, whereas the second group only accepts investments from an accredited investor. For example, P2P lending platform Validus only takes on accredited investors, with funds placed in an escrow account.
(An accredited investor is defined as a person with a net asset value of $2 million or more, and with an assessable income of at least $300,000 over the past 12 months).
Accredited investors typically have larger portfolios to manage; more importantly, they have access to products that can generate better returns despite the low-interest environment. Most wealth managers, for example, will suggest that accredited investors complement their portfolio with around five per cent in alternatives (investments besides conventional stocks and bonds).
P2P lending is one such possible investment, and is less risky compared to alternatives such as wine, art, luxury watches, etc. If you’re an accredited investor, speak to a qualified wealth manager on whether P2P lending could contribute to your portfolio.
In either case, the Monetary Authority of Singapore (MAS) regulates P2P lending through the Securities and Futures Act and requires platforms to implement safeguards to protect their investors.
It is worth noting that, while P2P lenders can assess and disburse loans faster than banks, they still screen borrowers for business viability, creditworthiness, and background. The majority of Singapore’s P2P platforms are reported to have default rates of below one percent.
What role can P2P lending play in an investor’s portfolio?
In general, a balanced portfolio should consist of a mix of high- and low-risk assets. During market downturns, the lower-risk assets—for example, fixed income securities and Central Provident Fund (CPF) savings—will be resistant to the effects of the economic decline.
At the same time, high-risk assets guard against inflation rate risk, and enable investors to grow or maintain wealth in the face of Singapore’s fast-rising cost of living. Ideally, investors would target returns that are at least two percent above the rate of inflation, which is around three percent per annum in Singapore and in most developed countries.
That means investors should, ideally, target returns of at least five percent per annum. This is far in excess of what fixed deposits can provide. To offset the low returns of their safer assets, investors need to consider an appropriate amount of higher-risk alternatives. A qualified financial advisor should be consulted on the proportion of high-risk assets for various investors. This will vary based on retirement goals, income, age, and other factors. But one of the high-risk, high-return assets to consider should be P2P lending.
Why invest in P2P lending?
P2P lending provides a number of advantages, namely:
- A high rate of return
- Diversification and distribution of risk
- Absolute returns
- Short commitments
- A simple and passive process
1. A high rate of return
P2P lending platforms mostly provide short-term, unsecured loans to businesses, thus allowing for a higher interest rate. Investors can derive returns as high as seven percent per annum. Of course, this varies based on the specific loan conditions and on the P2P platform in question.
Most passive investment products in the Singapore market deliver returns of only around three to five percent.
2. Diversification and distribution of risk
P2P lending sites provide a wide range of companies that investors can lend to. These can vary from small retail businesses to medium-sized companies in logistics or manufacturing.
An investor can diversify and distribute risk by investing small amounts in a wide mix of lowly-correlated companies. This ensures that no single default will wipe out their investment. Also, as the correlation between chosen companies can be low, no downturn in a single industry can impact the whole of their investment.
3. Absolute returns
Like many fixed-income products, P2P lending provides absolute returns. With unit trusts, for example, the potential returns vary with a benchmark index. But P2P loans have fixed repayment terms and interest rates, so investors will know exactly what they’re getting.
This makes P2P investing ideal for targeted financial goals, such as accumulating a specific amount for the down payment on a house or coming up with a certain amount of capital to start a business.
4. Short commitments
P2P loans are short term, and typically range from a few months to a year. This is helpful to investors who don’t want to be tied down by long maturity periods, such as 10-year bonds or fixed deposits.
By committing their money for shorter periods, investors are better able to capitalise on different opportunities as they emerge.
5. P2P investing is a simple and passive process
Simplicity is one of the greatest upsides to P2P lending. The investment is as straightforward as any investor can find: the money is loaned to a company (for up to a year), and the investor collects the interest.
There’s no need for an investor to pick sub-funds, assess the best timing for investment, or plan around the intricacies of guaranteed versus non-guaranteed returns. Compared to many financial products, such as structured notes, P2P lending is predictable and transparent.
P2P lending is not for all investors, but it can be a powerful tool for some
As with any financial product or asset, the appropriateness of P2P lending varies based on each investor’s portfolio.
However, investors should not dismiss it out of hand because it’s a relatively new form of investment or because of the perceived risk. Note, for example, that in Singapore defaults in P2P lending have been rare and of limited damage, unlike the incidents involving Lehman Brothers minibonds, the Swiber default, or the recent Hyflux debacle.
It will also benefit asset managers or wealth managers to look deeper into the prospect of P2P lending as an investment over the coming decade. Given the prevalence of a low-interest-rate environment, P2P lending is one of the few investment alternatives that can provide high returns while still being simple enough for any investor to grasp.