Mapping out the Funds Universe Part 1

Over the next couple of weeks in two articles we’re going to shine a light on the fast expanding mini-universe of London stock market listed funds investing in P2P loans and direct loans to small businesses.

Using numbers from investment trust analysts at Numis, we can clearly see from the various detailed tables below that this universe is now valued at over £1.5 billion – a remarkable number given that just under two years ago there were no funds at all, not the six that feature in the tables below.

Just to recap on why this sector has expanded as it has. The original fund – and still the biggest by a very long stretch at a market cap of just under £900m - was P2P Global Investments, managed by Eaglewood Europe and backed by hedge fund Marshall Wace.

If we look at the original investment strategy for this market leader we can see all the arguments for investing in a fund. In simple terms you get diversified access to lots of different platforms in the UK and globally, with customers that range from consumers through small businesses. In one fund, you in effect, get access to tens of thousands of different loans.

These are of course income focused vehicles, with the yields (or at very least targeted yields) varying between 6 and 10% depending on the underlying borrower.

Obviously these rates seem very attractive when compared to the market leading P2P lending platforms such as Zopa, Ratesetter and Funding Circle. The first two are focused on consumer lending and don’t offer anything above 6% whereas Funding Circle does offer the prospect of a blended yield of between 6.5 and 7%. Most of the funds here offer rates above that level but you also need to remember that you are taking some specific risks with a listed fund.

In no particular order we’d remind you that

1. You don’t benefit from any protection fund offered by the likes of Ratesetter and Zopa
2. You’re also investing in a share that is traded on the stockmarket which can be volatile in price and expensive to trade in (broking fees, bid offer spreads and fund management fees can all add up)
3. You are also particularly vulnerable to a fund moving from a premium to a discount. This sounds complicated but simply describes the relationship between the total value of assets in the fund and the market value or cap of the entire fund. If the market cap is valued at more than the underlying assets, the fund is trading at a premium, with the opposite a discount. Shifts between premiums and discounts can be dramatic and can damage your wealth. Take P2PGI for instance. If you’d have bought at the height of its premium you’d have endured a 19% premium whereas now the fund trades at a small discount. For more details on this see the first table below.

There is no right or wrong way to invest in p2p lending.

Some will prefer the direct platform approach, others (especially institutions) the fund approach. 

What we would say is that there has been a dramatic de rating of the sector by market investors. Premiums across the sector were very high at one point – probably unsafely so in our opinion. Now we can see that all six funds bar one, are trading at a discount. Our sense is that these vehicles should only ever trade at either the net asset value or slightly under.

The good news is that all the funds seem to be hitting their yield targets, with most paying out quarterly. But we’d also observe that the bid offer spread – the difference between the buying and selling price per share – is rather high in some cases with GLI Alternative Finance at over 2% (although it is the smallest fund in the space). 

How have these funds performed? The next table below again from Numis tells a worrying story. It shows price returns over various periods – not changes in the underlying net asset value of the loans. We’ve also included the various additional C issues for VPC and P2P (with Ranger currently also looking to raise extra money). Pretty much across the board we’ve seen noticeable price declines over the last month (figures are through to Thursday 19^th November) and even bigger losses over the six month period. Over the last year P2PGI is down by 4.2%.

These are meant to be permanent capital vehicles which means that 1 or 6 month performance numbers should be taken with a pinch of salt and arguably shouldn’t matter anyway for those with a 5 to 10 year time horizon – and those price returns also ignore the dividends you would have banked. We’d also observe that changes in underlying NAV aren’t substantial which all points to one important story – many investors might have sold the shares because they thought the premiums were too high.  We’d be worried if these price declines continued in the next six months and discounts started moving beyond 5 or even 10%. At the moment though we think the story is a simple one – investors have become more realistic about the sector and stopped putting silly prices on the shares. 

Another important fact is that all these funds operate with very different mandates. The table below shows the websites for each of the funds. We’d suggest that all readers visit these online, check out the monthly fact sheets and statements and really understand what you might be putting your money  into. GLI Alternative Finance for instance is very focused on small business p2p platforms from within the GLI Finance stable. That’s very different to Ranger which doesn’t focus on p2p loans at all, and prefers to make direct loans. Both VPC and P2P GI are much broader in focus and lend to both consumers and businesses. These latter two funds are also very much bigger and truly global.

The one area where there isn’t much variation is in charging – nearly all the funds (again bar GLI Alternative Finance) charge a base management fee of 1% plus performance fees in some cases. This isn’t extortionate but it’s not cheap. Many bond funds for instance stuffed full of fixed income investments look to charge well below 1% although these securities are arguably easier to research and trade in. If discounts do start to grow we wouldn’t be surprised to see pressure on those fund management costs, perhaps pushing them closer to 0.75%.

The one good bit of news – summed up in the table below which also looks at fees – is that the big institutions that backed many of these funds still seem to be ‘on board’. Neil Woodford’s fund management business is a sector champion as is Invesco, Aviva and M&G. We’d hope these big shareholders stay loyal, and over time we’d expect more funds to emerge.

Our bottom line? Next week we’ll look at these funds in comparison against other obvious alternatives such as bonds and mainstream equities plus investing directly in platforms such as Zopa, Ratesetter and Funding Circle. But without wanting to steal the thunder of that forthcoming article, we’d say that the recent price declines are healthy and have helped put the whole sector on a sensible even keel. Big premiums to net asset value were always dangerous and we’re glad that the sector is now trading back at a bit below par. If those income targets can be met, big institutional investors will probably remain committed although no one really knows what impact rising interest rates and even a recession could have  on the underlying business dynamics of the fast growing p2p lending markets.