Will Brokers Give DIY Investors Access to Direct and Marketplace Lending?

Institutional investors are pouring money into direct and marketplace lending strategies fuelling the growth of the sector. Notable recent fundraises include:

• Hayfin Capital Management raised more than €3.5bn for its direct lending strategy in February
• Park Square Capital and Japanese bank SMBC are setting up a €3bn direct lending JV
• Alcentra, the alternative fixed income arm of BNY Mellon Investment Management, raised €4.3bn for its European direct lending strategy.

Graeme Delaney-Smith, head of European direct lending at Alcentra said ‘having done due diligence, investors have now taken their opportunity to invest. It’s an asset class that they didn’t really have access to before because the banks were by and large the sole provider of lending across the European market – that has obviously changed.’

Stepping into banks’ shoes

Since 2007, asset managers have been lending money to companies as banks have retrenched. A decade on, the appetite is only increasing among institutional investors hungry for returns and wary of market volatility.

A recent Natixis survey of 500 global asset managers found that faced with volatility, greater risks and still-low yields, institutional investors are raising their exposure with 44% considering increasing the use of direct lending in the next 12 months.

‘the banks were by and large the sole provider of lending across the European market – that has obviously changed’

‘Momentum is really starting to build now,’ said Rohit Kapur, senior fixed income manager at Aon Hewitt. He said investors are interested in direct lending because they receive an illiquidity premium over traditional fixed income and are more comfortable now managers have established a track record since the market took off in earnest around 2012. The benefit of liquidity was also lessened in a low yield environment.

Hayfin managing director Glenn Clarke added: ‘Investors in direct lending strategies are compensated for the illiquidity as coupons are typically higher’, who also commented on the increased diversification.

Allocations

Institutional investors have de-risked their portfolios since the financial crisis, out of equities and into assets that better match their liabilities. To invest in direct lending, they have been allocating away from lower-yielding fixed income or further out of equities.

‘What we have tended to see clients do is reduce allocations to investment-grade and equities to make a risk neutral move into alternative credit including direct lending,’ said Gregg Disdale head of illiquid credit at Willis Towers Watson.

A direct lender added: ‘Credit is safer than the rollercoaster of equity and, in the end, investors will probably get the same returns; the returns from direct lending are basically just as good as equity.’

Pension schemes have allocated 5%-10% of their portfolio to private debt, including direct lending, real estate debt and infrastructure debt, said Sanjay Mistry of Mercer, sitting between their fixed income and alternative asset allocations, rather than falling into one or the other. Funds are also starting to invest across different managers to diversify their portfolios.

Retail investors are piling into the sector…but is this well guided.

Over 170,000 retail investors have invested in the sector directly on P2P platforms which will grow now bigger platforms, such as Zopa, are now launching their Innovative Finance ISAs. This direct distribution model has reinforced the sector’s mantra of disintermediation – a concept that retail and institutional investors alike value.

The liability driven investing of pension funds is a best practice example of objective driven investing, but are direct retail investors using the same rigour? The FCA is concerned that some retail investors do not, or are not able to, make fully informed investment decisions that help achieve their investment objectives. Put bluntly, are retail investors skipping the diligence, disregarding the asset allocation process and just chasing return?

As with all investing, it is about managing the risk around this return; whilst some are wise to the different business models and risk-adjusted returns available, a review of investor forums shows that many investors are searching for returns at the expense of a full understanding.

Are investors getting the appropriate advice and guidance to enable them to manage the potential pitfalls and investing in line with a well considered risk appetite?

‘the direct lending industry must work to enter traditional distribution channels’

Certainly more can be done, but the direct lending industry must work to enter traditional distribution channels…they are not going to come to direct lending and equally critical to financial planning best practice is full and efficient tax planning.

But the challenge for the majority of retail investors is that this can’t be done efficiently if the majority of tax wrappers sit on ‘wrap’ platforms that can’t handle unlisted products like P2P loans and debt based securities.

This is why Goji amongst others is working hard to bring about acceptance by more mainstream advice, guidance and investment channels to open up new investor markets.

To be clear, Goji fully supports, and in fact does the ISA administration to support, direct P2P distribution.  But with little infrastructure and support available for the unconverted mainstream investor or adviser through existing trusted distribution channels how can the sector truly reach the mainstream?

Equally, how can investors truly optimise their direct lending investments, as they can with other assets, if they can’t invest in their traditional tax wrappers?

Is the tide starting to turn in the advised market?

As a new asset class, traditional distribution channels (execution only or advised) have been treading carefully; whilst institutional investors can pour resources into research, other intermediaries are typically more focused on distribution of well understood structure and strategies.

‘we believe this is an opportunity to innovate so that we can embrace the sector in a ‘purer’ form’

There is also a question as to whether acceptance of the sector has been slowed by both the arduous FCA authorisation of many platforms and the poor performance of the sector’s investment trusts many of which are trading at discounts and undergoing performance reviews. This is unfortunate as the FCA process provides some assurance over the sector and investment trusts are well understood structures and widely accepted in tax wrappers and investment platforms and therefore an easier way of of attracting mainstream investors into the sector.

In light of the headwinds against adoption of the sector it is of little surprise ‘direct to (P2P) platform’ has struggled in traditional channels. But we believe this is an opportunity to innovate so that we can embrace the sector in a ‘purer’ form. The mark to market equity wrapper of the investment trust added volatility and correlation to what is otherwise a systemically isolated financial instrument. But new distribution methods and technologies are emerging that hope to preserve the attractive underlying investment attributes of the assert class whilst tapping into existing structures.

Goji is one of a breed of new managers who are emerging with innovative new products that preserve the uncorrelated, low volatility nature of the underlying investments whilst affording eligibility for inclusions within tax wrappers.

To find out more visit www.gojip2p.com