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P2P investment trusts see some discounts widen

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QuotedData research director James Carthew has commented on the P2P investment company sector, as discounts on P2P trusts widen. 

“Trusts focused on peer-to-peer lending have caught investors’ attention, raising over GBP1.8 billion in just a couple of years,” Carthew says. “Investors are attracted by the relatively high levels of income yields on offer and the popularity of the sector means many funds trade at a premium to asset value. However, the two of the largest in the sector have suffered from widening discounts and are yet to take decisive remedial action.
 
“In an abnormally low-interest rate environment, investors are struggling to achieve decent levels of yield. It is no wonder then that alternative finance funds promising yields between 5 per cent and 10 per cent have been in demand from institutional and retail investors.
 
“Well known investors such as Mark Barnett and Neil Woodford have allocated significant amounts to the sector. Honeycomb was a new investment for Edinburgh Investment Trust run by Mark Barnett, as revealed in Edinburgh’s recent annual results, and Invesco subscribed for three-quarters of the Funding Circle SME Loan fund’s GBP14.5 million placing in July.”
 
Carthew notes that the listed funds tend to be either focused more on lending to the SME market or to consumers. “The experience of the UK investment companies sector to date has been that SME lending has proved to be less prone to defaults than consumer lending. This is potentially because SME lending tends to be characterised by better credit quality and higher underwriting standards (loans are assessed individually rather than against a quantitative model). SME loans are also more likely to be secured, which increases the chances of making a full recovery in the event of a default.”
 
In a peer group comparison of the peers, Carthew notes that the peer-group average is pushed up by the performance of Ranger Direct Lending, a split capital trust. He writes: “The vast majority of Ranger Direct Lending’s assets are denominated in US dollars and the greater part of this is not hedged – consequently, the recent strength of the US dollar against sterling flatters its returns.
 
“The share price performance of P2P Global and VPC Specialty Lending, trusts with a greater focus on consumer lending than the other funds in this table, has lagged this year and these trade on the widest discounts, while those focused on SME lending have fared better The SME Loan fund (SMEF) trades on the third widest discount and is more focused on SME lending, as are Ranger Direct, Funding Circle SME Loan fund (FCIF) and Hadrian’s Wall Secured Investments. Honeycomb Investments partakes in both consumer and SME lending, but is more focused on the former."
 
Carthew continues: “Other defining features of the funds within the sector are leverage levels, secured loans versus unsecured, and the sourcing of the loans. Many of these funds, except for SMEF and FCIF, invest or intend to invest in the equity of some of the platforms that they lend through. Mixing equity and debt in these funds confuses the message to investors, ups the risk of losing money and, we think, is a distraction for the managers from the day-to-day business of analysing the quality of the loans they are making.
 
“One argument in favour of taking equity stakes is that it can ease the due diligence process when analysing platforms. In practice, though, it is unlikely that any fund would be reckless enough to lend money through a platform without undertaking thorough due diligence on it regardless of its ownership status.”
 
Carthew believes that another, more powerful, argument is that having an equity stake may help ensure that the fund has access to loans originated on these platforms. “FCIF addresses this issue by being a captive fund – it only invests in Funding Circle loans. SMEF benefits from its relationship with GLI Finance (GLIF) which owns a 50 per cent stake in SMEF’s asset manager.
 
He concludes: “Here, perhaps, the benefit is stronger as GLIF owns more substantial stakes in most of its platforms and therefore has greater influence over them while SMEF, which is managed entirely independently of GLIF, has no monetary interest in the success of those platforms and is therefore free to pick and choose which loans it invests in while not being tempted to compromise on quality by directing business to a platform it has an equity stake in.”

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