‘Safe’ P2P investments are not suitable for longer term investors
No one wants to lose money on an investment. We work hard to save the money that goes into our investment portfolio. To avoid the risk of losing money, many P2P investors opt for products that offer low returns (3-4%) but appear to be safe. They receive assurances that they can exit their investments if money is needed quickly. We think there is certainly a role for these types of P2P products, such as Zopa in the UK. However, we think there is a risk that P2P investors may be allocating too much of their capital to these types of products, when much higher returns are available elsewhere over the longer term, regardless of the future economic environment. We explain why below.
Let’s run some scenarios and see what happens
Let’s assume we have 2 investors, each with £/€ 100,000 to invest:
Carol places her money into P2P platforms that offer loans secured by real estate. She buys loans with an average interest rate of 12% pa, which all have an LTV of 70%. Carol is saving for retirement and is happy to keep here investments for at least the next 5 years.
Mike receives an inheritance. He knows that he shouldn’t just put it in the bank with an almost zero interest rate, but he is not so sure about the stock market. It looks expensive. So instead he invests it into the Zopa Core product at a rate of 3.9%. He lets it keep rolling over and in 5 years time logs in to see how much his Zopa account is worth.
Scenario 1 – UK and European economies perform as expected
The UK and European economies grow in line with expectations at 1-2% pa. House prices are flat. Loan default rates are at normal levels. Any defaults on secured loans are covered by the loan collateral and there are no losses for investors.
At the end of year 5 Carol and Mike review the value of their P2P portfolio:
Carol has £/€ 176,100. Mike has £/€ 121,000. By taking the safer, stable option, Mike has £/€ 55,100 less than Carol. His account is now worth 31% less than Carol’s account.
But at least he didn’t lose any money, and the economic conditions assumed were fine. What if a big recession hit…?
Scenario 2 – A huge crisis hits in 4 years time
How would Carol and Mike’s portfolio perform if, in 4 years time, another global financial crisis hit? Let’s assume that property prices fell 40% in every country, and the default rate on Carol’s loans reaches 50%. Carol also has to pay legal and administration costs equivalent to 10% of the value of the collateral she recovers. Her average recovery rate is 77% on the defaulted loans.
Now let’s take the extremely optimistic assumption that Zopa is not affected by this crisis in year 5, and Mike continues to earn his 3.9% return.
At the end of year 5:
Carol has £/€ 149,000 vs Mike with £/€121,000. Even after the impact of the severe crisis, Mike still finds himself £/€ 28,000 behind Carol. Even with a very pessimistic scenario for Carol, and a very optimistic one for Mike, he is still far behind.
Scenario 3 – Breakeven scenario vs Zopa
It is possible to model a scenario that over 5 years would result in Mike and Carol ending with the same portfolio value. For this to happen, we would need to assume real estate value declines of 50% everywhere, and a loan default rate for Carol of 56%. It would also require Zopa’s investors to not be affected in any way by this crisis (clearly this is unrealistic, and we would actually expect returns to be negative in this scenario).
If you would like to run your own scenarios, or see how we calculated the figures, the file can be downloaded here
This shows how important it is to be selective and strategic with P2P investments
Most P2P investors today are much more similar to Mike than Carol. The majority of money is flowing to larger P2P platforms that offer some promises around protecting against losses, and an ability to exit. We think there is a role for these types of products. However the analysis above shows why it is so important to consider how long you are willing to invest for, and what your opportunity costs are. There are very good opportunities at the moment for investors who are a little more sophisticated than average and are willing to take a longer term view.
Is it really possible to earn 12% on secured loans like Carol?
Absolutely. Some great options for UK investors include Bridgecrowd and Lendy. European investors can find loans with this profile on EstateGuru, Bulk Estate, and Mintos. All these sites offer interest rates of 12%+ with LTVs no higher than 70% (in many cases much lower). We think they are worth considering as part of a diversified investment portfolio, or as an alternative to P2P funds that are earning low returns elsewhere.