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Investing in Peer-to-Peer Lending Is Far From Retail-Ready

By Miriam Rozen August 21, 2015

Six months ago, a company called NSR Invest — formerly Nickel Steamroller — began offering its services as gate-opener to advisors who want, in turn, to offer their clients investment options in the emerging peer-to-peer lending space.

But “limited” remains the operative term, says the Denver-based firm’s chief, Bo Brustkern. There are in fact fewer than 10 FAs on his client list.

That’s no shock to Peter Hand, director of quantitative strategies for San Francisco-based Aperio Group, a firm that manages around $10 billion. He says P2P lending has never been tested — as it might have been had it existed in 2008. This leaves advisors to undertake “a lot of homework and due diligence” to determine which P2P loans are investmentworthy, he explains.

Hand also believes there’s a structural flaw in P2P lending. Unlike traditional banks, most of the upstarts don’t offer other products to sell borrowers to justify the marketing expended to attract borrowers in the first place. In addition, investors in P2P loans gain no tax protection on the income they earn, he says.

And Hand ought to know. Before he joined Aperio early this year, he tried launching his own P2P lending firm.

Still, says Hand, the concept behind P2P lending is attractive because “there are a lot of inefficiencies in traditional banking.” Some banks aren’t good at delineating nuances between prime and subprime lenders, so they overlook potential borrowers who represent good credit risks for investors.

To exploit this gap, P2P lenders are developing algorithms — using once ignored or unavailable data — to distinguish among the borrowers that old-line lenders now underserve. By pairing attractive but underserved borrowers with willing lenders, P2P companies can — in theory, says Hand — create a sustainable market.

That’s why NSR is so keen to complete beta testing of its algorithm machine — a platform run by a portfolio-management-system provider that Brustkern declines to name.

But that’s just one hurdle on the firm’s way to winning significant business from financial advisors. In the main, doubts persist about almost all the peer-to-peer lending start-ups — including Prosper and Lending Club. These boil down to questions about the real-world efficiency, over time, of their algorithms, and their ability to pay for all the business-to-consumer marketing it will take for them to attract enough borrowers to compete.

In point of fact, NSR’s next move — on completion this year of its platform beta test — is a big marketing drive, says Brustkern.

But retail investors may be at least as hard a sell on P2P lending as are retail borrowers.

Doug Nordman writes about personal finance for The Military Guide, a website for U.S. armed-service personnel and retirees. He tells FA-IQ he’s recommending his readers steer clear of P2P plays because they afford too little sight into “the risks that you’re unwittingly taking.”

P2P “interest rates are set by the companies using proprietary software that estimates default rates from history,” Nordman adds. But those companies don’t have enough history to be able to show how P2P plays might perform in a recession.

Still, NSR is betting the prospect of strong returns will attract the attention of advisors’ clients. And advisors themselves should expect to hear more directly from industry cheerleaders soon.

“We’ve only just started to hit the conference circuit,” says Brustkern.