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Three alternative reasons to consider peer-to-peer investing

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Written by: Stewart Cazier
03/11/2017
With cash holdings in low interest paying bank accounts being slowly eroded by inflation, many investors have been attracted to the enhanced income offered by alternative – or ‘peer to peer’ – lending.

However, any investment where capital is at risk – such as alternative lending – is not covered by the Financial Services Compensation Scheme (FSCS) and should not be considered as a substitute for cash deposits. So, why should investors look at the burgeoning alternative lending sector? There are three possible reasons:

Diversification

Diversification is often referred to as ‘the only free lunch in finance’. This means investors should hold a variety of assets with different underlying risk drivers to ensure an entire portfolio is not dramatically derailed by a single factor or event.

Alternative lending is interesting from this perspective – it is one of the few income options available to retail investors that is largely shielded from market volatility. With many markets trading at high valuations – and therefore more vulnerable to a fall – this has become increasingly important.

Institutional investors understand this, which is one of the reasons why alternative assets are so popular with this segment of the marketplace – notably areas such as infrastructure projects, including toll roads or power generation. These alternatives typically provide a steady return and the values are not directly dependent on market forces.

It can be tricky for retail investors to access these opportunities directly. Fortunately, the alternative lending space offers similar characteristics. It is one of the few ways a retail investor can diversify away from everyday market volatility and risk.

Funding your income needs

Income-seeking investors often have long-term predictable needs in mind when choosing investments – such as retirement income or school fees. Traditionally, investors have held a portfolio consisting of equities and bonds, alongside some cash.

The problem here is that many investors rely on selling assets gradually, in addition to the income generated, to meet long-term income needs. A major dip in the market is not necessarily a problem when accumulating long-term savings, as holdings generally recover the lost value over time.

However, those investors obliged to sell holdings in a market downturn will forever lose the opportunity to recover the lost capital. The impact on long-term planning, such as retirement, can be dramatic. Alternative lending can help avoid these pitfalls as investors can fund their income needs from regular repayments from their borrowers, and so should not need to sell assets in market dips.

Managing pension allowances

Alternative lending certainly offers attractive returns relative to other investment options, as well as against cash at the bank. ThinCats has achieved average returns for investors of 7%-8.5%(as at 11 Oct).

Even if you are not an income-seeking investor, alternative lending could make a valuable contribution to a diversified pension portfolio – whether it is in the accumulation of wealth phase or later on in the retirement savings period.

There are a number of different investment needs where achieving a balance between higher returns, which can shorten the time needed to achieve the goal, and volatility, which may unexpectedly delay it, are very important. For example, the investors saving for a home deposit. Another is a SIPP investor close to the lifetime allowance seeking to maximise the available allowance before retirement – without paying tax charges for exceeding it.

Of course, investors must remember there is the potential of illiquidity in alternative lending – so it is important investors are confident the money allocated will not unexpectedly be required before it is due to be repaid.

Stewart Cazier is head of retail at ThinCats

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