Why investors are fleeing the ‘fear and greed’ of stock markets for peer-to-peer loans

Investors are ditching the stock market in favour of bundled loans sold by fledgling platforms that are yet to be tested by a financial crisis.

After a year of turbulence in the markets, investors are switching their stocks and shares Isas to innovative finance Isas in large numbers.

This new type of Isa was launched in 2016 to allow people to access peer-to-peer (P2P) loans, which involve individuals and small firms lending to each other, cutting out banks.

Returns range from about 4pc for lower-risk loans, to 10pc or higher for more speculative loans, often involving property developments.

Data compiled for Telegraph Money by RateSetter, a P2P firm, showed that as , there was a spike in the number of transfers into innovative finance Isas.

Between , the proportion of switches from stocks and shares Isas rose from 9pc of transfers to 22.4pc. In the same period the FTSE 100 fell from 7,748 to 6,728, a drop of 13.2pc. RateSetter said it had seen the biggest increases in customer transfers on the days that stock markets performed worst.

This uncertainty, in the UK and further afield, is beginning to weigh on investors, she said. Diversification is an important consideration for investors in almost any situation, but it becomes an increasing concern during times such as these.

This is where the innovative finance Isa can come in, as it offers access to companies and projects that are not directly correlated to the volatility of stock markets.

Michael Nevell from Bromley, Kent, is one investor who has switched from payday loans in Maryland stocks to P2P in recent months. The 42-year-old, who works in financial services, first invested a small sum in P2P in 2017 and has since increased his holdings.

Mr Nevell earned up to 6pc from RateSetter and, as his other investments in the stock market stumbled, he decided to move all of his Isas to P2P last autumn. I had my own stocks and shares Isa but I found it was a lot of maintenance, he said.

I decided to close out that Isa and transfer it. P2P has its own risks but I feel there is more certainty in the income I get. With shares and even bonds, when some bad news comes out the whole investment can get panned.

Achieving diversification

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Neil Faulkner of 4thWay, a P2P analyst, said that this type of investment came with its own issues but also significant advantages. Money lending is intrinsically lower risk than buying shares for several reasons, he said.

Mr Faulkner explained that lenders were more likely to be able to recover debts quickly if their P2P investment turned sour, compared with a company on the stock market failing.

This is because platforms themselves have a better understanding of when loans are likely to go bad, as they have historic data to draw on. Also, it is easier for investors to spread cash across multiple loans and platforms, he said, than to achieve similar diversification on the stock market.

Most money lending involves waiting for your borrower to repay the loan and interest, whereas stock market prices are hugely influenced by fear and greed, causing massive fluctuations, Mr Faulkner added.

However, the unique risks of peer-to-peer should not be underestimated. The biggest mistake newcomers can make is to spread their cash across too few loans and exclusively target high-risk, high-return investments. Rather than shielding them from stock market fluctuations, this could actually leave them overexposed to economic shifts.

Many of these investors will regret it when the next recession comes, Mr Faulkner warned. A minority of them compound that error by concentrating their holdings on niche, higher-risk, higher-rate lending that suffer a lot of defaults and delays in recovering bad debts, as well as greater losses on individual loans.

He recommended spreading cash across at least half a dozen different low-risk accounts. Also check what would happen if the platform itself was to go bust, as this could also cost investors money if wind-down plans are not robust.

‘I should be able to weather any trouble’

Ms Groves encouraged investors to choose platforms that display their fee structure clearly and perform stringent checks on borrowers. Check what has been done for you and any research you may need to do yourself, and also see whether a third party has carried out any analysis of risk, she said.

Ms Groves said investors should try to identify the rate that the borrower is paying, as this can give an indication of how risky the investment is, rather than simply looking at the rate of return offered to investors.

Find out if the loan or bond is backed by assets or secured’, as this can be a good way to manage risk, she added. These loans typically have a saleable item, such as a property, as security in the event the borrower fails to repay.

If not, it’s also worth checking if there are other lenders and if your loan is senior’ to theirs, meaning you get paid first, she said. Mr Nevell said he was aware of the risks associated with peer-to-peer but said he chose his platforms carefully.

P2P is invested in many areas and the whole economy would need to take a big hit for an investor to be damaged, he said. I should be able to weather any trouble.»