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What Are P2P Lending Investment Trusts?

Cliff is an experienced freelance investment journalist. Read about Cliff.

P2P lending investment trusts

At the end of September, I wrote an article explaining how UK investors can make money by investing in specialist funds that themselves lend investor money through peer-to-peer (P2P) lending websites or sometimes even buy shares in P2P lending businesses.

Several 4thWay readers have asked for more information on how these “investment trusts” work, so here we are…

What is an investment trust (IT)?

An investment trust (often abbreviated to IT) is an investment fund, but with a difference.

With most investment funds, investors' money is used to buy units within the fund. The money they used to buy units is invested on their collective behalf by a professional fund manager. Investors’ profits (or losses) are linked to their number of units in the fund.

However, with an investment trust, there are no units to buy.

Instead, the trust's shares are listed on the stock market, just like any other stock-market company. This means that investors looking to invest in a particular investment trust simply buy its shares through a stockbroker, just as they would when buying shares of, say, BP, HSBC or Vodafone.

And, just like BP or Vodafone, you could get paid regular profits (a “dividend”) and also make – or lose – money based on the movement of the share price of the fund.

Ten things to known about investment trusts

1. A trust's share price may not match its underlying assets

Assets in a trust are the things that the trust has bought using investors' money.

In P2P lending investment trusts, the assets they own are mostly the loans they have made through P2P lending sites. Hence, if a P2P lending investment trust has lent £100 million through P2P lending sites, its total assets will probably be worth roughly £100 million too.

The share price of an investment trust partly relies on the value of its assets.

However, the share price is also affected by investor sentiment. If investors pile into a trust's shares, this buying pressure might push up its price. Conversely, selling sprees might put downward pressure on a trust's shares.

2. A trust's shares can trade at a premium or a discount to its assets

At times, the value of a trust's assets (the things it used investors' money to buy) can be very different from its market value (the total value of all the trusts shares).

For example, a P2P lending investment trust with 200 million shares trading at £2 each has a market value of £200m x £2 = £400 million.

If this trusts' underlying net asset value (NAV; its total portfolio/asset value) is above £400 million, then the trust's shares are said to be trading at a premium to its NAV.

However, if this trust's NAV is below £400 million, then its shares are trading at a discount to NAV.

In other words, if the investment trust is lending £400 million through P2P lending sites, the combined value of all its shares on the stock market at any one time might be e.g. £410 million or £390 million, and individual shares can therefore be bought for more or less than all the P2P loans in the trust's lending portfolio.

Jargon What it means
Investment trust (IT) An investment fund listed on the stock market. To invest in an investment trust, investors buy shares in it, just like buying shares in Apple or BP.
Market value The total value of all shares in the investment trust, based on the price investors are currently paying to buy its shares.
Assets The things the investment trust buys using investors' money.
Portfolio Usually interchangeable with “assets”, a trust's portfolio is the investments that the investment trust holds. If the trust has lent £10 million through RateSetter and £20 million through Zopa, that is its “portfolio” of investments, as well as its “assets”.
Net asset value (NAV) This is the total value of all an investment trust's assets, which in P2P lending investment trusts usually means its P2P loans. If the investment trust itself has any debts, those debts are deducted from the asset value to get the “net” asset value.
Trading at a premium When the buying price of an investment trust's shares is higher than the value of its assets.
Trading at a discount When the buying price of an investment trust's shares is lower than the value of its assets.
Dividend Profits made by an investment trust that are paid out to the investors who own its shares.

3. A trust has a limited number of shares

Investment trusts are ‘closed-ended funds', which means that the number of shares in circulation are fixed.

On the other hand, conventional investment funds can simply issue more units to meet increased investor demand.

If lots of investors want in, the limited supply of shares at investment trusts can cause the share price to rise when there are more interested investors than shares available.

That said, popular investment trusts can increase their number of shares in issue by selling new shares to meet heightened demand.

4. At times, trust premiums and discounts can be fairly wide

Depending on investor demand for its shares, and movements in its NAV, a trust's premium or discount to NAV may widen to double-digit percentages.

For example, shares in Honeycomb (HONY), one trust that invests in P2P loans, currently trade at a premium of nearly a sixth (15.9%) higher than its latest published NAV. This indicates that its shares are very much in demand with investors since the trust came to market in December 2015.

At the other end of the scale, shares in Ranger Direct Lending (RDL), another P2P lending investment trust, trade at a discount of nearly a third (30.6%) to its NAV. This wide discount follows a wave of write-downs at RDL due to loans turning bad.

* All share prices as at Friday, 3 November 2017

5. Buying at a premium means paying more than £1 for £1 of underlying assets

When you buy shares in a trust that trade at a premium to NAV, then you're effectively paying more than £1 to buy just £1 of underlying assets. Then again, if a trust's managers are outperforming, then it may well be worth paying a premium for these superior results.

For example, with HONY's shares price currently at 1,178p for 1,018p of the trust's assets, this equates to paying £1.16 for each £1 of P2P loans.

If this premium continues to widen, then you may make money, but if it falls (i.e. if the share price falls from £1.16), then you could lose out.

A higher share price also lowers the dividend you earn. If Honeycomb shareholders who bought at £1 per share earn, say, 8% in dividends, then buying at £1.16 means you earn under 7% in dividends.

6. Investment trusts take management fees from investors

In return for managing investors' money, fund managers expect to get paid for their efforts – and this is no different for investment trusts.

That said, trusts' yearly management fees – known as their ‘ongoing charge figure' or OCF – can be lower than those levied by conventional open-ended funds.

For example, HONY's OCF is 1.33% a year (calculated and taken monthly, 1/12th at a time), while RDL's OCF is 1.86% a year. These OCFs are fairly steep as, in the universe of investment trusts, yearly OCFs can be below 0.5% for mainstream funds.

Those investment-trust fees are on top of any fees that the trust will pay to various P2P lending sites on your behalf.

7. You can buy P2P lending investment trust shares inside a tax-free ISA

You can buy investment trusts' shares through almost all stockbrokers and investment platforms, in the same way as other UK-listed shares.

What's more, if you prefer your income and capital gains (profits from selling shares) from investment trusts to be tax-free, then you can buy their shares inside a tax-free ISA (Individual Savings Account). Why pay tax needlessly when you don't need to?

Note that investment trusts are bought inside stocks and shares ISAs, because you are buying shares in these trusts that are listed on the stock market. This is different to IFISAs, which is a kind of ISA for when you are lending directly, outside of an investment trust.

Most lenders can earn at least some interest and make some capital gains without paying taxes, even outside of ISAs. Read more in How Is Peer-to-Peer Lending Taxed?

8. You might make or lose money by investing in trusts

As with all forms of investing, buying shares carries a number of wealth warnings.

Depending on:

  • A share's individual performance and the timing of your buying or selling, and
  • The dividend you are paid by the fund (which will usually reflect the interest received by the investment trust on the P2P loans it has made)

You could turn a profit or make a loss (get back less than you put in).

In other words, there are no guarantees when it comes to investing in shares, including trust shares.

9. P2P lending investment trust shares can be more volatile

As research elsewhere on this website demonstrates, P2P loans can produce a steady and attractive income for patient investors who spread their money around wisely.

However, the returns from P2P lending trusts' shares tend to bounce around much more widely, which makes them much more volatile than directly investing in P2P loans.

The higher their volatility, the more suddenly and steeply shares can move up and down in value.

Nevertheless, for investors unable or unwilling to do the investment spadework themselves, investment trusts can be an option worth exploring.

10. Always do your homework before buying any shares!

One final warning: as with investments of all shapes and sizes, it pays to do your research before hitting the ‘BUY' button to buy into investment trusts. One excellent source of data on investment trusts is TrustNet, a well-known fund website.

Read moreHave Investors Really Made Money From P2P Lending Funds?

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