Don’t like equities and want absolute returns? Besides bonds, one possible option is P2P lending. The proliferation of these platforms in Singapore offers an interesting alternative to investment markets; and it can be appealing to investors who like predictable returns, but find bonds too cumbersome. But before you jump into it, consider if the implications and risks are right for you:
What is P2P lending?
Short for Peer-to-Peer lending, this concept is broadly thought to originate with Zopa, a UK based company, back in 2005. There is some dispute about that though:
While Zopa is probably the first actual P2P lending company, it’s also alleged that certain projects involving microloans (e.g., platforms allowing you to lend small amounts to farmers in developing countries, for agricultural tools) were the original pioneers.
Regardless, the core concept behind P2P lending is simple: it allows the lender to connect directly with the borrower, without having to go through conventional financial institutions. This is believed to benefit both lender and borrower.
For example, SMEs and start-ups typically struggle to get business loans, because they don’t have a track record of profitability yet. But where a bank may be unwilling to lend to them, an investor (or pool of investors) from the public may be willing.
Likewise, investors may be unhappy with the relatively low interest rates from bond coupons or fixed deposits. Those with the risk appetite and capacity may be happy to lend directly to a small business or individual, at a much higher interest rate.
The P2P platform connects these two sides, and acts as an online facilitator.
Reputational damage and reform, after China’s P2P collapse
P2P lending as a whole took a serious hit in 2018, due to a crisis in China. At the time, China had allowed its P2P platforms a free hand.
The P2P platforms were at liberty to branch out into various services, such as acting as wealth managers (despite lacking the financial credentials to give advice), and acting as guarantors for loans (despite lacking the funds to actually meet those guarantees).
Ironically, China’s attempt to crack down and regulate the funds – which came too late – caused an industrywide collapse. Investors who had parked funds with shady P2P lenders saw these companies taken down, and their money went with the purge.
We never experienced such situations with P2P lenders in Singapore, as MAS provided tight regulations from the start. As of 2023, P2P lenders are regulated under the Securities Futures Act (SFA) and Financial Advisers Act (FAA).
This aside, the chaos in China has caused some notable changes:
- It’s rarer to find P2P lenders who give loans to private individuals. In Singapore, P2P lenders only make loans to SMEs, not to retail borrowers (i.e., you won’t end up lending money to someone to buy a Furla bag). Overseas though, there are P2P platforms that will do that.
- Some P2P platforms now require lenders to have accreditation. In Singapore for instance, at least one major P2P lender requires that you be an accredited investor, before you can be a lender.
- P2P platforms are no longer “free and easy” in their acceptance of borrowers. These days, SMEs that apply to join P2P platforms also need to go through credit checks.
- P2P platforms are much more thoroughly audited, in most countries. It’s also increasingly the norm for P2P platforms to hold funds in escrow accounts, rather than handling the funds directly (e.g., any funds sent to borrowers, or repayments received from borrowers, go to an escrow account managed by a licensed third party. It doesn’t go into the P2P company’s account, so they can’t shut down and run off with the cash).
Why would you want to participate in P2P lending?
P2P lending typically constitutes the high-risk segment of your investing. These loans generally involve short term (six months to 12 months) loans to SMEs, for which you get a much higher interest rate than most savings products.
In Singapore, it’s not unheard of for some P2P loans to offer interest rates between 15 to 20 per cent per annum.
Besides the higher rate, some investors like having an absolute return. P2P loans are a form of debt, so the repayments don’t change like stock dividends. You always know exactly how much you’re supposed to be paid back.
The short-term nature of the loan is also appealing to some investors, because it means greater flexibility. Unlike a fixed-deposit, the money you lend isn’t locked away for five, 10, or more years.
You lend, and you get it back with interest in a matter of months.
Another appeal is the degree of control you’ll have, as a lender. Different platforms have varied methods but in general, you get to choose which SMEs you lend to. If you’re an impact investor, for example, you can cherry pick and lend to sustainable companies, or companies pursuing agreeable goals like renewable energy.
Okay, why wouldn’t you want to participate in P2P lending?
Because it’s lending. As in sometimes, people may not pay you back.
Now different platforms have different ways of mitigating risks. For example, some platforms pool the loans among a group of companies; so even if one company defaults, you likely won’t lose the entire amount you’ve put down (e.g., out of the $10,000 you’ve loaned, you may find you’ve lost $2,000 or $3,000 but not the full amount).
Other platforms are rather straightforward though: if the SME you loan to can’t pay you back, you just lose the money (so it’s probably best to spread out your capital in many small loans, to many different SMEs).
Bear in mind that SMEs, and especially start-ups, are by definition high-risk.
Another possible downside is loan restructuring. This is when a borrower can’t pay you back, but at least tries to. It may mean a reduction in the interest you can charge, or an outright haircut (e.g., paying you 70 per cent of what you’re supposed to get, but it’s better than nothing).
For these reasons, P2P lending shouldn’t constitute a large part of your portfolio. It’s typically used in small doses; such as five per cent of your portfolio in a barbell strategy, or bundled with other risky assets like high-yield bonds and collectibles.
It’s very important that you talk to a qualified financial advisor or wealth manager first, to get a sense of how much you can afford to invest in this.
One other drawback is the hands-on portion
Being able to choose borrowers isn’t a plus point to every investor. Not everyone wants to pore through the details of every potential borrower, trying to figure out which SME is the best one to lend to. It’s a time-consuming process, and it can cause a lot of anxiety.
If you dislike doing this, you may be better off with a conventional managed fund.
Overall, P2P lending can work for those with a higher risk appetite. It’s also of use to investors who like absolute returns, but need a higher risk product to balance out their lower-interest fixed deposits and T-bills.
But investors who don’t believe in SMEs, start-ups, and short-term loans are likely to be unnerved. If you’re one of them, ask your financial advisor for another option. You can also reach out to us at Single Digit Millionaire if you have any questions, and we’ll be happy to help.
