Anyone looking for a theme tune for the wave of peer-to-peer loan and direct lending fundsAlt Income: your guide to P2P & direct lending funds to hit the stock market in the past four years couldn’t do better than ‘Too Much Too Young’ by The Specials.
The title of the Coventry combo’s caustic 1980 hit captures the rise and, in some cases, fall of the eight investment companies hoping to fill the gap left by banks after the 2008 credit crunch.
By making high interest rate loans to consumers and businesses struggling to get credit, these funds aimed to provide good quarterly dividends for their shareholders. Unfortunately, dividend cuts and disappointing returns have left the first funds to float on the London Stock Exchange in 2014 and 2015 trading on low valuations. By contrast, shares in more recent fund launches continue to command premium prices for so far keeping their promises to investors.
The result is a ‘two-tone’ sector: offering cheap shares standing on discounts of up to 27% below asset value for bargain hunters looking for growth opportunities; and more expensive stock on premiums of up to 16% for income investors looking for reliable dividends and high yields.
Robert Burdett, co-head of multi-manager funds at BMO Global Asset Management, likes the sector because whether the funds lend through online peer-to-peer websites or more traditional intermediaries, their loans are generally short-term with ‘floating’ interest rates that will rise when interest rates go up. Burdett said they had ‘no duration risk’ which means they will be less vulnerable if the Bank of England hikes interest rates quickly than the conventional corporate bond funds, which many investors hold for income.
Ian Rees, deputy head of multi-asset funds at Premier Asset Management, said for growth investors comfortable with the risks the cheap loan funds offered an opportunity. ‘Getting access to these kind of assets at this level is attractive,’ he said.
However, Paul Craig, manager of the Cirilium fund portfolios at Old Mutual Global Investors, advised income investors to focus on quality and avoid the cheaper funds that have experienced problems. Paraphrasing the words of master investor Warren Buffett, Craig said: ‘It’s better to buy a good company at a fair price, than a fair company at a good price.’
‘Bargain’ loan funds
Topping the list of bombed-out shares is sector pioneer P2P Global Investment (P2P). Like the young mother who is the subject of the tirade from singer Terry Hall (pictured third from right) in Too Much Too Young, P2P greedily grabbed all life’s chances and raised £870 million from investors in 2014-15. That was a mistake. Struggling to invest its huge cash pile, its returns and dividends failed to meet expectations. Although the portfolio has never made a loss, investors dumped the shares, which dropped 16% last year.
They are flat this year having dropped 10% since September after declaring a drop in half-year dividends from 25p to 23p per share. This has reduced its market value to £638 million.
Some investors take encouragement from the merger this year between the fund’s manager, MW Eaglewood, and Pollen Street Capital, which runs the more successful and highly-rated rival Honeycomb fund. P2P has begun to reduce its US holdings and increase investments in the UK to make it more similar to Honeycomb. This has led to speculation the two could eventually merge, given that Mark Barnett, star income fund manager at Invesco Perpetual, holds over a third of both shares.
At a 20% discount to net asset value (NAV) and a 6% dividend yield, P2P offers scope to bargain hunters but Rees expects a long haul. ‘It will take 12-18 months to put it on a much healthier level,’ he said.
Progress is being made, however. The company today announced it had found a buyer for a 'significant proportion' of its US consumer loans, although it postponed a detailed strategy update, that had been expected last week, until the end of the month.
Alternatively, shares in Ranger Direct Lending (RDL) trade on a whopping 28% discount and, even after a dividend cut, offer a forecast yield of about 6% at 775p. The £125 million fund, which is managed by Ranger Capital in Dallas, Texas, suffered a blow when a big investment in a US fund was hit by the bankruptcy of Argent Credit, a consumer loan website in Chicago. Ranger has since reported that investments with six out of 13 platforms were suspended.
It’s an ugly situation with the shares down 20% this year, although with activist investor LIM Advisors holding a 9% stake and the company announcing talks with potential new co-managers, Ranger may have hit rock bottom.
VPC Specialty Lending (VSL) is another struggling US-based fund. Managed by Chicago-based Victory Park Capital, it has faced defaults on its consumer loans but is switching focus to invest in lenders, where it has a better track record, said Lees. After an 11% fall last year, the £286 million fund has returned 6% this year. The shares stand on a 17% discount to net asset value (NAV) and yield 8.8%.
SQN Secured Income Fund (SSIF) has also undergone changes in its short life. Launched two years ago as GLI Alternative Finance, it switched names twice to reflect changes in its fund manager and investment remit. Since April SSIF has focused on loans to smaller and medium-sized businesses in the UK as it aims to lift annual dividends from 6.25p to 7p by next July. However the £50 million fund has been overshadowed by woes at its larger sister SQN Asset Finance Income (SQN) and its shares stand on a 2% discount to its asset value.
Shares SQN Asset Finance Income, an equipment leasing fund, last week fell to 92p, below their 2014 launch price of 100p, and a 6% discount after SQN forced Snoozebox, the portable accommodation provider to which it had loaned £10 million, into administration. The £329 million investment company indicated it would recover its money but investors are worried following the bankruptcy in April of its biggest borrower, US solar panel maker Suniva.
Investors have challenged SQN why it has not written down the value of its loan to Suniva but it insists it will recover its money and that the restructuring of several other of its loans are just part of delivering a high yield - currently 7.9% - through monthly dividends to shareholders.
Burdett agreed investors had to be aware of the risks: ‘In all lending you have defaults. They control the asset. They have recourse. You don’t have that with a bond fund.’]
Premium loan funds
The four newest loan funds that have so far avoided mishaps largely specialise in lending to smaller and medium-sized enterprises (SME) or businesses in the UK, which reduces the risk of currency movements to which the more US-focused funds are exposed.
Launched in July 2015, Funding Circle SME Income (FCIF) is the oldest and differs in being the only one to lend through a peer-to-peer platform, its parent Funding Circle, which keeps down costs. At 102p shares in the £170 million fund stand at a modest 1.5% premium over asset value and yield 6.4%.
The other three funds are run by experienced teams of credit managers who extend secured loans to a small number of companies spread across different sectors.
RM Secured Direct Lending (RMDL) raised £30 million from investors last month, to top up the £50 million it attracted at its flotation last December. On a 2% premium, the shares are not expensive and offer a dividend yield of 4%.
Shares in Hadrian’s Wall Secured Investments (HWSL) are more highly rated, their 105p price standing at 9% above asset value, lowering their yield to 3.8%. It launched in June last year.
Honeycomb (HONY), in which Neil Woodford, the UK’s best-known fund manager, holds a 17% stake, is the most expensive. At £11.80 the shares trade on a 16% premium above asset value, propped up by an even higher dividend yield of 7.7%.
Craig likes the fund but said its shares were too dear at this level. ‘I see a greater risk of premium erosion than from bad debt,’ he said. He suggested investors put it on their watch list and see if a buying opportunity occurs should the company issue new shares at a cheaper price.