Fixed-income investing is in a weird place, caught between historically low interest rates and the Federal Reserve’s looming interest rate hike that will usher in the end of the three-decades-plus bull market in U.S. debt and likely hammer the price of existing bonds. Given that, it’s little wonder why many investors don’t know what to do with the fixed-income portion of their portfolios.
One possible alternative is peer-to-peer (P2P) lending, which has been around since the dawn of money in the form of hitting up family and friends for money to help fund a business venture, purchase property or whatever. In recent years, technology and the Internet have changed the game by spawning efficient online platforms that match borrowers and lenders on a wider scale, thus creating a whole new investment opportunity.
P2P lending—also known as marketplace lending—works like this: Borrowers unable to get a bank loan go to an online P2P site and fill out some personal information and specific financial details about the loan. The P2P company analyzes the data and, if there are no red flags, approves the loan and assigns a credit grade and loan terms. Investors on the P2P platform provide money for the loans and choose which ones to fund in return for the promise of making returns generally exceeding what’s available in the fixed-income market (other than, say, investing in Greek debt).
The online P2P market began in the middle of the last decade and has grown beyond the fad stage as P2P lending platforms have proliferated and the amount of money flowing into the space, particularly from institutional players such as hedge funds, endowments, pension funds and the like, has increased exponentially. According to industry statistics, online P2P lending platforms originated roughly $9 billion in loans last year, up from $100 million in 2009.
Some people predict that number could zoom to $1 trillion within 10 years. And now that Goldman Sachs plans to start its own online lending platform to compete against entrenched leaders including Lending Club and Prosper Marketplace Inc., it’s kind of like the Good Housekeeping Seal that says, “Hey, this is legit.”
The P2P space is an area financial advisors are tiptoeing into. Jeff Nauta, a principal at Henrickson Nauta Wealth Advisors in Belmont, Mich., says his first real exposure to P2P lending came a few years ago when a client who operates in investment banking circles suggested the firm should look into this asset class. “My initial thought was there’s no way we’re going to invest client money in P2P lending because it seemed too risky to make uncollateralized loans to individuals.” (Many P2P loans, such as those on the Lending Club and Prosper platforms, are unsecured.)
But to satisfy the client, Nauta’s firm contacted a hedge fund the client recommended, Colchis Capital Management in San Francisco, which runs the Colchis P2P Income Fund investing on the Lending Club and Prosper platforms. Colchis educated Nauta’s firm about its proprietary data feeds with those platforms, about the software it developed to bid on loans and about P2P lending in general.
Nauta liked what he heard, and today at his firm qualified clients who have at least $5 million in investable assets have a dedicated allocation to P2P lending ranging from 2% to 6%—that is, if the clients are comfortable with this type of investment. “We have some clients who just can’t get over the hump of this asset class,” he says.
So far, he’s pleased with P2P’s ROI for his clients, noting that the Colchis fund has had consistent returns of 0.7% to 0.9% a month. “Our goal is an annualized return of 9%,” Nauta says.
“We consider P2P lending to be a fixed-income alternative and we put it into the alternative sleeve of client portfolios,” he adds. “We want to be clear with clients that we’re investing in a hedge fund with limited liquidity, and even though it’s a fixed-income alternative, it’s not your government bond fund.”
For lower-net-worth clients, Nauta has been kicking the tires on the managed account platform offered by NSR Invest, a Denver-based outfit that was created earlier this year after a merger of two entities staffed by P2P lending veterans.