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Lend Direct or Use P2P Investment Funds?
Updated on 23 June 2015.
P2P Global Investments is a P2P investment fund that has just raised another £250m from investors, who had already handed over £200m at its launch in May 2014.
The most interesting aspect of this is whether we should be lending directly or going the managed fund route.
P2P investment funds: watch the costs
I take the view of Benjamin Graham, the founder of modern investment analysis and an astoundingly good investor over a very long period. He was deeply scathing of professional fund management, when it started to arise and spread in his lifetime.
He knew that the extra layers of costs lowers investors' average returns.
Consider the impact in peer-to-peer lending. Let's say the average return is 6%. Well, roll up all the fund managers who take on P2P altogether in a ball and flatten them out, and they're going to be average too.
But they'll cost you extra in management fees, auditing expenses, legal costs, and other disbursements. So, on average, those of you using a fund manager will make just 4% to 5%. Less if they take performance fees, as all the P2P funds seem to do right now.
This is not just theory. The impact of fund management costs in other investments has been very well documented and is not in dispute. Due to their high costs, fund managers achieve the seemingly impossible: almost all of them are below average!
Not as simple as they seem
Another disadvantage of P2P funds is that they're all currently structured as “investment trusts”.
While there can be advantages to this structure, the disadvantage is that it means the price you pay to buy into the fund goes up and down, rather like buying shares on the stock market. That's because these funds are companies listed on the stock market!
You buy into them by buying shares in them. Hence, if the fund is doing well and getting a high return, the share price will rise, and that will counter the benefits of owning the fund in the first place.
Here's an example. Say the shares start at £10 each and the return is 5% per year. Let's say you buy when the share price rises to £12 each, but the interest rate is still 5% based on £10, not £12. So your own effective interest rate is not much over 4%.
The flipside is that you might get a bargain at times, when the share price falls. (Although the same could also be said of buying loans directly, particularly when buying second-hand loan parts.)
But this all adds to the complication of buying funds, when the whole point of the funds is supposed to be to make your P2P investing even easier than buying direct.
Take the middle way
There are some very simple rules to lending your own money yourself safely. We've got four for you in the 4-Step Strategy to Safe Peer-to-Peer Lending.
It's incredibly simple, unlike stock picking. That's just as you'd hope, because the potential rewards are also more modest.
Strangely, I'd say it might even be easier to manage your lending directly than to get to the bottom of an investment fund's prices and hidden costs, or to assess whether its management is still doing a good enough job.
But, if you still prefer funds, watch out for P2P index trackers. These don't exist yet, but they will. And they'll be your best bet when they do.
Had stock market index trackers existed when Benjamin Graham was complaining about funds, he would not have been so scathing of these particular funds!
Like his protege, Warren Buffett, the most successful investor in the world, he would surely have favoured trackers for the vast majority of investors.
They key thing about them is that they are incredibly cheap. They're all average. But incredibly cheap. So, when we get a P2P index tracker, on average you might make 5.7% or 5.8%, while the average lender using an actively managed fund is still only making 4% to 5%.
Again, this is not just theory; index trackers for other investments have proven their class over many decades now.
A can of Coke for the person who can find that passage in Intelligent Investor where Benjamin Graham is most disparaging of professional money management. Or was it Security Analysis? It's time I read those books one more time!