Peer-to-Peer Lending: A Fad or the Future?
Peer-to-peer lending may serve advisors’ clients on two fronts, experts say. Wealthy clients looking for a high-yield alternative to traditional bonds can invest in funds that pool loans to small-business owners. Meanwhile, business-owner clients who might be having trouble getting a bank loan can secure financing from online marketplaces that connect borrowers and lenders.
But it’s an untested and little-known space for advisors. Skeptics warn these marketplaces will have to accept ever riskier borrowers to maintain their growth momentum. Meanwhile, funds that pool such loans have yet to prove they can survive a serious market downturn. Those risks may explain why some advisors avoid them. And peer-to-peer lending got a black eye recently when its biggest player, Lending Club, revealed a net loss of nearly $33 million for 2014, just two months after raising $1 billion in its December IPO.
None of these factors dissuades Matrix Capital Advisors from putting clients into peer-to-peer investments, according to cofounder Michael Wik. The Chicago firm manages over $600 million for clients with an average net worth of $15 million. About 80% of its clients have 5% to 7% of their portfolios in the Direct Lending Income Fund, which is open to accredited investors.
“I actually feel confident that P2P does a much better job than the banking space at vetting loans,” says Wik. He argues underwriters in the space have as much skill as bank underwriters — if not more, judging by the performance of giant institutions during the financial crisis. “You would have been much better off owning a portfolio of these loans in 2008 to 2009 than loans at a traditional bank.”
His preferred peer-to-peer fund is the product of Direct Lending Investments, which Brendan Ross founded in 2012 after working as a management consultant and running a few small firms. The fund has about $150 million in assets and is growing by $15 million a month, according to Ross.
Advisors can find the fund on the Fidelity, Schwab and Millennium Trust custodial platforms. Loans in the fund average about $60,000, one year in duration and default rates of 5% to 6%. Borrowers include doctors and dentists, as well as owners of restaurants and gas stations. They pay interest of 20% to 30%, according to a Direct Lending fact sheet on the fund. Investors, meanwhile, can retrieve their principal with about a month’s notice, and can expect returns of 10% to 12% based on historical data, the fact sheet says. That’s a whole lot of basis points more than what they get from bonds these days. “Fixed income in traditional form is done,” he declares.
Peer-to-peer investments can be suitable for many types of clients, including retirees and widowed grandmothers, according to Scott McCartan, CEO of Millennium Trust. In addition to supporting the Direct Lending fund, the boutique firm also serves as a custodian for Lending Club. Millennium Trust wants to make its mark by specializing in alternative products and sees peer-to-peer lending as a key component.
Advisors with small practices, though, are likely to continue avoiding the peer-to-peer space. A prospect recently asked Kristi Sullivan of Sullivan Financial Planning in Denver whether he should invest in peer-to-peer lending. She admitted she didn’t know much about it and suggested the prospect could try it on his own, by replacing the high-yield bonds in his portfolio with peer-to-peer holdings. Sullivan, who mainly charges project-based fees, says she works in a “plain-vanilla world” and has few clients who would consider peer-to-peer lending.
Allan Katz of Comprehensive Wealth Management in Staten Island, N.Y., so far hasn’t fielded any questions about peer-to-peer lending, but he’s not impressed with the investment concept. According to Katz, who collects commissions and other fees as well as a percentage of assets, such funds lack sufficient historical track records, asset levels and lending requirements to make him feel comfortable recommending them. “These companies are not mature,” he says, “and inherently carry a great deal of risk of going out of business.”