Investors go digital in hunt for yield

Marketplace lending has traditionally fallen beneath the radar of institutional investors, but digital finance strategies can help connect them to the growing market.

It’s been more than a decade since the first marketplace lenders entered the lending scene. Zopa established itself in 2004 to provide loans to consumers, while FundingCircle followed shortly after targeting investments in small and medum-sized enterprises. Alongisde RateSetter, both firms make up the big three MPLs in the UK market.

P2P Finance Association, the UK-body representing the leading MPLs, has recorded more than £8 billion ($10.3 billion; €8.8 billion) in loans since it started tracking the data towards the end of 2014. Both consumers and businesses, who’ve found little success at the leading banks, have turned to MPLs which connect lenders to borrowers by harnessing the advantages of digital platforms.

As the market continues to grow, the doubts about its long-term viability fall. And as the firms establish a healthy track record, a group of firms, describing themselves as digital finance investors, are building a portfolio of loans and generating an income for institutional investors.

Hadi Habal, chief executive of HCG Fund Management, told PDI that he moved into digital finance investing in 2012. “I was looking at the intersection of three objectives: high returns, low risk and short duration assets with the potential to deliver liquidity and offer optionality. It means you can adjust to uncertainty at a time when nobody knows what is going to happen over the next 12 months,” he said.

Such strategies apply leverage and can return between nine and 11 percent, while investors are exposed to a huge pool of loans underwritten by the platforms, therefore reducing the downside risk. So far, they’ve been present in the more active US market, but they are increasingly looking towards Europe as the continent embraces the technology.

Brian Weinstein, chief investment officer of US-based digital investment firm BlueElephant said that the “growth of MPL, both in terms of origination volumes and securitisations, show that institutional comfort with the asset class has grown.”

BlueElephant, which has a history of investing in unsecured consumer debt of prime borrowers in the US and New Zealand, has recently shifted into buying secured loans as credit markets continue to heat up.

“Given where we are in the credit cycle, we see prime secured lending significantly outperforming unsecured. This is a significant differentiator – we’ve written the credit model to ensure that we are acquiring loans that satisfy our credit criteria,” he said.

Similar to the MPL firms, digital finance investors use technological methods to analyse the data and select the right loans to acquire. Habal said: “You’re going to see a continued progression of more sectors move from analogue to digital. That’s why we have invested in terms of people and systems to make technology a core competency.”

The task for MPL is to diversify the investor base making catching the attention of institutional investors a top priority. Both Zopa and FundingCircle have gone down the route of securitisation, while property lender LendInvest recently reached £100 million on its closed-ended fund.

Digital finance investment firms offer an additional route for MPLs to access institutional investors – and it has come at an important time as pension funds and insurance companies look to a new generation of direct lenders in their quest for yield.