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How 4thWay’s CEO Selects P2P Lending Sites

I have always invested in investments that are relatively easy to analyse, so that I have a good chance of being able to weigh up the risk-reward balance properly, and invest with a large margin of safety. The types of investments I choose also need to come with total costs that are low enough to be able to offer fair returns to the investor.

For investments like that, you can always put the risk-reward balance greatly in your favour with some simple rules. Peer-to-peer lending fits the bill, so here are my rules for selecting peer-to-peer lending accounts to lend through.

1. A checklist of unwavering principles

I am a firm believer in 4thWay’s 10 P2P Investing Principles. That is as you might expect, since I was their co-author five years ago. Please take a look, if you want to dramatically improve your chances of success. They are more important than all my other points below.

If I am not satisfied that a P2P lending account passes all the 10 rules then I simply will not trust any of my money to it. If a P2P lending account only just passes any of the rules then I lend less money through it.

2. Data-based approach

One of the huge advantages of lending as an investment is that it is not as fluffy as analysing many other kinds of investment. That is not to say that subjective investments are all bad, but it just means that it's not always as easy to read the risk-reward weighing scales.

Most types of lending is tailor-made to be analysed from a data and results perspective.

By being able to see how they have performed at preventing loans falling late or going bad, and in recovering bad debts, you can learn a great deal about the ability of the key people behind a peer-to-peer lending site. They all claim to be capable of running a P2P lending site properly and not all of them are correct. So the data really shows what's happening.

A data-based approach includes seeing how their numeric lending criteria compares to banks or other P2P lending sites doing similar lending. An obvious example is the “loan-to-value”. This means if the P2P site does real property (real estate) mortgages and limits the amount that a property owner can borrow to 65% of the property value, you can quite easily see with a comparison across multiple P2P lending sites and banks that this compares well and puts the loan-to-value clearly at the much safer end.

An approach based on data means that you need to lend across a large number of P2P lending sites and a great number of loans. Otherwise, you're throwing all your estimates and analysis out to chance.

Softer facts count too

A data-based approach includes softer data that you can check off a list.

Specifically, I look for a declaration from the key people that they have all the exact experience and training I would expect them to have for the kinds of loans that they do.

So that's not just “banking experience”, which could be a clerk counting cash for all we know. But instead it's e.g. credit-risk analysis for personal loans, or bad-debt collections for secured business loans. (If you want to get into softer data and a more advanced approach to lending, take a look at How To Assess P2P Lending Websites.)

Soft data to me is also loosely counting the number of times I slightly raise an eyebrow at some niggling point, and I also count the descriptive information that is missing, such as the actual career history of a key person, or the processes used to select borrowers or recover bad debts, or if I have felt it was hard to get the information I needed.

Softer data also includes any information the peer-to-peer lending site gives us about their methods. One of the examples that I have noticed the most is whether they state that they are focused exclusively on getting fantastic security for lenders and don’t worry too much about the borrower quality, or whether they are intensely interested in both. It's clear from results that the latter approach lowers the risks (even if that stricter approach makes it harder for P2P sites to close deals and grow their businesses).

You do need to feel you can trust any data, soft or hard, although that point is covered in the 10 Principles.

3. My gut is important to me

As you can see, I rely a lot on the numbers and results and the ratios they use, such the loan-to-value. The more details they provide, the harder it is to fake and cover up, and so the more credible they are.

Indeed, the first thing I do is take a cold hard look at all the facts I can, before I allow someone to work on me by trying to build a personal relationship (which I resist).

Incidentally, the same applies to P2P lending sites when they are looking to approve business loans. 4thWay's specialists have told me that banks typically get better results when they take a look at the potential borrower from a distance first, before allowing the business the opportunity to charm them. That is the same when we “approve” P2P lending sites.

But I also believe in my judgement of people’s character. So far, since I founded 4thWay, when I have suspected I’m talking to someone at a peer-to-peer lending site who is a rogue, or a delusional, naive or inexperienced person, this has typically been borne out in what has happened next in terms of the P2P lending sites results or actions.

The reverse has also so far been true, when I have felt I am talking to a highly honest or experienced person.

So I’ve come to rely on my gut more as time goes by. I like to put it to use in checking the plausibility of any statements P2P lending sites have made about their abilities, results and the rest.

Sometimes it is the gut that helps us interpret faint signs: whether we have detected an unnecessary nervousness, or received somewhat contradictory statements, or picked up a strong sense of bluster.

Deception here is always a risk. At 4thWay, all the experts, and all our investment journalists too, are required to use a specified set of processes to reduce the risk that charm and other techniques of manipulation will influence our views of a P2P lending site.

One of the techniques we use in direct talks with P2P lending sites has been proven to boost accuracy in correctly identifying when we are being lied to by an additional 40%. When we combine all the techniques we use, I think that it really helps us to maintain arm’s length independence and quality.

4. Dig deeper

I like to really keep pushing and figuring out whether the people at the top are professional, disciplined, honest and experienced, and to check out why there are any anomalies in their stories or any of the data.

And I don't stop digging even after I start lending, because it never hurts to have more knowledge and because we have seen strong banks turn weak over time.

5. Topgrading

To round all the above off, I personally prefer the “Topgrading” approach. This is used in the recruitment industry, but I find it just as appropriate when investing.

In a nutshell, Topgrading means: “If there is any doubt at all, the answer is No”. And then you don't lend through that P2P lending site.

Look for changes that might make your past decisions obsolete

By “changes”, I'm not talking about recessions or property crashes, because you should expect those sorts of changes and build them into your plan, so that you can keep lending through those times with a bare minimum of stress and worry.

What I'm talking about is major changes at the P2P lending site. E.g. are they suddenly approving twice as many loans when they were already very large. Smaller ones can double more easily without weakening their borrower selection standards, but you wouldn't expect the same of, say RateSetter, which does around a billion in lending a year.

Or have they substantially weakened their criteria, e.g. they used to cap property loans to 75% of the property value but are now setting 85% as the cap.

Investing in any industry is most successful when most people are being cautious. But after long cautious periods, discipline relaxes as everyone starts to think: “Nothing's gone wrong before, so we can stop being so strict.”

That's when the shit hits the fan.

If the P2P lending site's proposition changes and makes you think, “Hang on! Is this the same platform I was investing in previously?” then it is time for you to reduce or wind-down your lending until the P2P lending site proves its new standards are sufficient through a downturn.

Read more

4thWay’s 10 P2P Investing Principles.

How To Assess P2P Lending Websites.

Independent opinion: 4thWay will help you to identify your options and narrow down your choices. We suggest what you could do, but we won't tell you what to do or where to lend; the decision is yours. We are responsible for the accuracy and quality of the information we provide, but not for any decision you make based on it. The material is for general information and education purposes only.

We are not financial, legal or tax advisors, which means that we don't offer advice or recommendations based on your circumstances and goals.

The opinions expressed are those of the author(s) and not held by 4thWay. 4thWay is not regulated by ESMA or the FCA. All the specialists and researchers who conduct research and write articles for 4thWay are subject to 4thWay's Editorial Code of Practice. For more, please see 4thWay's terms and conditions.

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