A key consideration in peer-to-peer lending as well as when investing in any asset class is liquidity. Investors should always be asking themselves: How long is my investment horizon? How much of my portfolio do I need to access and how quickly? What happens if I need to access my money early? Will I be charged for accessing my money early? What happens under adverse market conditions?
When it comes to peer-to-peer lending (P2P), liquidity is a particularly important consideration, because the underlying loans can have fairly long maturities, often up to 5 years. Many investors in peer-to-peer lending may forget that they are actually entering into a loan agreement as a lender, as opposed to simply investing in a certain asset. When an investor commits money to a peer-to-peer platform, they are entering into a loan agreement which is essentially a commitment to lend a certain amount of money to a certain borrower for a defined period of time. This means that you, the lender, are on the hook for that defined amount of time and have no legal right to access your capital early so long as the borrower is abiding by the terms of the loan agreement. It is especially easy to forget that P2P lending is a relatively illiquid asset class by definition, due to the ease of investing on nicely-designed platforms.
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While all of this is true, most P2P platforms have clever mechanisms that allow investors to access their capital early. Typically, to access your money early, platforms will facilitate the sale of your loan obligation through a secondary market or automatically re-allocate your loan obligation to another lender. So, as long as capital continues to flow into the sector and sentiment remains positive, it is likely that investors can access their money early. But, it is an important point to remember that you can only sell your loan obligation if there are other investors who are willing to buy it. Some platforms will charge a fee for selling your loan obligations and some platforms offer specifically designed early access products which do not charge such fees. Below is a summary of early access terms from the largest three platforms to give you an indication of what this looks like.
Peer-to-Peer Lending Liquidity: Accessing your funds early on Funding Circle, Zopa and RateSetter
Platform Early Access Fees
Funding Circle Investors can sell their loan parts to other investors on the Funding Circle secondary market. They have an “auto-sell” tool to help investors with this. 0.25% fee. Investors can also offer a discount of up to 3% for quicker sales.
Zopa Investors can access their funds early by selling active loans to other investors on the market. As there is often a high demand for borrowers on the Zopa platform, investors can often receive their funds back quickly. 1% fee for investors in the Classic and Plus products. Investors in the Access product can withdraw funds at anytime free of charge.
RateSetter Providing there are new investors on the RateSetter markets, current investors in RateSetter can withdraw their funds before the end of their term. Average fee of 0.72%. The rate earned will also be reduced to reflect the time invested: if invested in the 5 Year Market, but funds were withdrawn after one year, the RateSetter system would reduce the interest rate down to that of the 1 Year Market. Rolling Market product has no fee.
A couple of things to be aware of when you are doing this is that (a) it can cause a cash-drag on your portfolio, due to cash sitting idle in your accounts and (b) it may increase your administrative burden, as you will need to manage your capital flows.
Peer-to-Peer Lending Liquidity: Early Access Accounts
As outlined above, some peer-to-peer platforms offer specific products designed for early access. Typically, these accounts allow investors to withdraw their capital under normal market conditions almost immediately and free of charge. These products generally have lower rates associated with them. RateSetter and Assetz Capital, for example, offer early access products which offer rates of 3% and 3.75% respectively.
“Under normal market conditions” is an important phrase here. While these products offer early access, under normal market conditions, the investor is still investing in loans with maturities of up to 5 years in both the RateSetter and Assetz Capital products. Therefore, the underlying liquidity of the assets has not gotten shorter and is certainly not aligned to the daily liquidity offered by the product. The loans are still subject to the requirements of finding a buyer or alternative lender in the market. Under normal market conditions, the platforms are confident that they can do this and so are confident that you can access your money early. However, under adverse market conditions, there is a chance that no buyers or lenders will want to take on the loan and so you will not be able to access your money.
Investors should view these products as having the advantage of being specifically designed for early access and thus make the process easier and faster for the investor, while not charging a fee for this service. They should not be seen as a way to improve the underlying liquidity of your loan commitments.
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Peer-to-Peer Lending Liquidity: Under Adverse Market Conditions
As discussed, you can only access your money early so long as there are buyers or other lenders who can take on your loan obligations. This is fine under normal market conditions, but what happens under adverse market conditions? Well, it may mean that there are more people wanting to sell their loan obligations than those wishing to buy them. In this scenario, investors may need to offer discounts to encourage people to buy their loans, or may not be able to sell at all. If liquidity were to dry up and you cannot find a buyer or an alternative lender, you will be obliged to hold your loan to term.
On its own, this is not necessarily a bad thing, as the underlying loan may not be affected by the adverse market conditions and you will simply be earning interest as usual. The trouble is, adverse market conditions may come hand in hand with an increasing number of borrowers defaulting on their loans, reducing your return expectations. To put this all into context though, peer-to-peer lending is not a unique asset class from this perspective. The majority of financial investments may see liquidity dry up and/or see a negative performance impact under adverse market conditions.
Peer-to-Peer Lending Liquidity: Best Practices
Ultimately, investors should be be aware of the liquidity and terms of the underlying loans within their peer-to-peer lending portfolios. Holding illiquid assets should not be something investors should be scared of. In fact, some of the world’s most sophisticated individual investors and largest institutional investors actively seek to hold more illiquid investments to harvest the so-called “liquidity premium”. The liquidity premium is the extra return that is demanded by investors in return for accepting lower levels of liquidity. While some investors need fast and easy access to their cash, others can afford to take a longer-term view of their investment portfolio and are suitably rewarded for that. Win win. When it comes to P2P lending, investors can take advantage of the attractive, stable yields on offer, while also taking advantage of the bonus mechanisms on offer, through the magic of the peer-to-peer platforms’ technologies, in order to gain early (and often free) access to their capital. Investors just need to be aware of the risks: liquidity may dry up in adverse market conditions.
Investors can achieve best practice by ensuring they (a) understand the real liquidity of their portfolio, and view the early access mechanisms as a bonus, (b) size peer-to-peer lending within their portfolio appropriately, dependent upon their liquidity tolerance, and, (c) diversify their holdings as much as possible to best-place portfolios for adverse market conditions. As always, we recommend that any investor conduct independent research and analysis on their investments, which we believe empowers investors to make more informed investment decisions and ultimately leads to better risk-adjusted portfolio performance.