Most people find the topic of investing money a nuisance. But in view of the debate about interest rates sliding into negative territory, savers are getting restless. One of the alternatives to savings deposits that has received little attention so far is peer-to-peer lending (P2P lending).
The myth includes savings deposits, whose importance has increased significantly again since the financial crisis, according to data from the Bundesbank. Apparently, people continue to value them as a haven of stability. And despite increasingly puny interest rates (0.52% in December 2014), the total volume of savings deposits with agreed notice periods of up to 3 months remains stable at 530 billion euros.
However, in view of the debate about deposit interest rates sliding into negative territory, even German savers are getting restless and looking for alternatives. One of the not-so-new alternatives, but one that has so far received little attention in Germany compared to savings deposits, bonds, shares or funds, is so-called peer-to-peer lending (P2P lending), which is a sub-form of crowdfunding (I have already explained the different variants here).
In P2P lending, a company or an individual obtains its loan via an Internet platform from a group of individuals, each of whom invests only a fraction of the desired loan amount as an investment. In return, they receive repayments and interest at fixed times, the amount of which depends on the potential risk. The Internet platform attempts to assess the risk of loan payments not being made as agreed and displays the respective credit rating of the loans for this purpose.
In principle, anyone can invest money via lending platforms under certain minimum conditions. Institutional investors have long since discovered the advantages of this asset class. In Germany, private individuals can provide loans to companies and individuals via platforms such as Smava, Finmar, Auxmoney, Lendico, Zencap or Bondora. The platform Auxmoney has just announced that over one million euros per day are financed and thus invested via its platform. Despite this growth, the total volume of this market in Germany is still small. In the UK, over a billion pounds flowed into this asset class last year, according to a report in the Financial Times. The U.S. company Lending Club has just announced that over $1.4 billion of new loans were financed via its platform in the last quarter of 2014 alone.
Still too little risk information from platforms
Information about the risks of the loans is part of the platforms’ standard. However, this information alone is not sufficient because it does not provide any information about the quality of the credit ratings. With the exception of Bondora and Smava, the platforms active in Germany do not provide sufficient data on how good their risk classifications have been in the past.
The model here could be the data provided by the leading and now listed US platform Lending Club. From the data provided, investors can see, for example, what the originally agreed interest rate was and what actual interest rate investors effectively received after deducting defaults in the respective risk classes (see table).
Such data are, of course, only approximations because investors only ever invest in a fraction of the loans on offer. Lending Club shows elsewhere that with broad diversification, it is possible to get close to the effective interest rates shown in the table.
Conversely, this means that the less broadly an investor can spread (= diversify), the more his expected interest rates will fluctuate around the stated values. From a spread of about 250 to 300 loans, Lending Club considers a P2P investment to be sufficiently diversified (low volatility in terms of effective interest). In plain language, this means: If you want to invest 10,000 euros in P2P loans, you would have to distribute them among at least 250 loans of 40 euros each. However, based on historical data, he then has a high probability of still receiving an interest rate of 8.33% even if he chooses the loan class with the highest risks. This sounds attractive and attracts many institutional investors in the USA and England.
Asset or portfolio manager needed for diversification
If you want to spread your investment amount over 250 loans, it is of course not practical to look at each loan individually. The time required for the investment would thus be too high. It is much more convenient if the platforms offer an investment or portfolio manager. Such “bidding agents” allow a one-time amount to be invested automatically within a certain period of time according to selected criteria. Of the above platforms active in Germany, Auxmoney, Bondora, Smava and Lendico offer such a manager.
However, patience is required to achieve broad diversification. Spot checks show that the number of loans offered simultaneously per risk class is well below 250. There is still a lack of corresponding market breadth here.
Interesting asset class
The calculation of risk-adjusted lending rates in the lending business is not an arcane science, but it is not trivial for the average investor. It is therefore all the more necessary for the platforms to use an appropriate statistics engine to make transparent on an ongoing basis how well their valuations have matched in the past. Only when this information is available in sufficient quality and an automation tool facilitates investment can this form of investment be recommended as a genuine digital asset class. Of course, it is not a substitute for savings accounts, because even with optimal risk diversification, unforeseen events can lead to unpleasant deviations, as the financial crisis has shown. Unlike savings deposits, there is no deposit insurance.