For the many, not the few

Does exposure to a larger number of underlying credits via peer-to-peer lending platforms offer added value for investors?

Private debt fund managers will no doubt be familiar with what modern portfolio theory says about diversification. By allocating across multiple assets, investors may be able to generate the same returns while reducing risk.

It’s the reason why debt funds don’t pile all their capital into one loan and why investors will likely pick more than one debt fund to allocate to. The very rationale for an initial allocation to private debt may well be rooted in diversification ambitions.

Peer-to-peer lending platforms may, therefore, have a strong selling point to investors seeking access to alternative lending. Why, they will argue, invest with a debt fund exposed to 20 credits – where a single default could have a severe impact – when you could invest in a portfolio of hundreds, if not thousands, of loans?

P2P lenders generally aren’t involved in the same types of loans made by credit funds. Firms such as Funding Circle and Lending Club are fishing for much smaller deals and borrowers. For this approach to be worthwhile from a business standpoint, you need to make a lot of loans.

Certain asset management firms in the US are now beginning to offer investors the chance to invest in fund products exposed to P2P lenders. One such example is Stone Ridge Asset Management, which runs the Stone Ridge Alternative Lending Risk Premium Fund.

The fund’s annual report, published in February, is more than 2,000 pages in length. Most of these pages list the underlying loans the fund is exposed to via platforms including Zopa, SoFi and Lending Club. It’s a demonstration of just how diverse an investment in a P2P lender can be.

The logical follow-up question, however, is how does such a portfolio perform relative to a private debt fund? According to the same annual report, Stone Ridge’s fund returned 9.53 percent from June 2016 to February 2017.

That’s certainly on a par with some private credit funds as well as indices that could be roughly used as proxies for the industry. Through May, the Credit Suisse Leveraged Loan Index, for example, had a one-year return of 9.88 percent. The S&P/LSTA US Leveraged Loan Index has returned 10.16 percent over the same period.

In its annual report, Stone Ridge champions the diversity of its fund, singling out its “breadth” of investments as a reason for the returns achieved. The report, however, does contain one important proviso:

“As a result of certain economic incentives received from platforms that may not be available in the future, the Fund’s performance was unusually strong for the period shown and should not be extrapolated for future periods,” it says, without additional clarification.

Therefore, more time may be needed before investors can take a view on whether the comfort of loan diversification is achievable without any significant erosion of return.