Sophisticated investors are always on the hunt for the new thing—whether it’s an emerging technology; a breakthrough in the way we communicate; a pharmaceutical product that cures, saves or enhances life; or an alternative source of energy.
Things that never existed before live up to the definition of “new” and can produce wildly successful profits for early investors. But as disruption is laying its wake through traditional industries and business sectors (Uber upending transportation; Airbnb, lodging; Trulia, real estate), one financial play of tomorrow may exist in finance itself: Consumer lending is getting a makeover aided by technology and refined by peer-to-peer groups.
Moreover, there is an inherent ethic in peer-to-peer lending that positions it nicely for the millennial crowd and those who want to make a difference with their money—impact investing types.
By eliminating the legacy bureaucracy of banks and financial institutions, lending groups can provide access to capital to a larger swath of the consuming public who are turned off and often turned away from traditional institutional lending approaches.
Beyond further servicing the retail market’s credit needs, these lending groups can also service investors’ needs by positioning themselves for intermediary investments. “Our mission is to keep the peer investor in the P2P markets,” says Bo Brustkern, co-founder and CEO of NSR Invest, a lending platform that connects investors and borrowers and which provides a plug-and-play marketplace for financial advisors. He says institutions have largely taken over the P2P sector from an investment perspective. Yet it is advisors who hold the keys to discretionary capital. “We arm [financial advisors] with tools to participate in the P2P marketplace,” he says.
To that end, NSR provides a unified peer-to-peer investment platform for financial professionals. It even translates terms into familiar financial services industry language: higher returns, lower correlation, transparency, fees, etc.
The platform is dubbed an “investor service platform,” and this is how it works: Borrowers apply for a loan through an origination platform (such as Lending Club). If approved, the loan is listed at Lending Club, where investors can choose to invest in the whole loan or a small fraction of it (as little as $25 per note). The NSR platform “sees” these loans as soon as they are listed and scores them based on dozens of borrower attributes. NSR then quickly invests its clients’ money in the loans with the highest scores.
Considering that borrowing capital can be expensive for consumers and small businesses—with usury limits of 30% and 50%, respectively—and that investors are yield-starved, P2P investing seems like a pretty good match for borrowers, creditors and investors alike. And if initial data is any indication of future results, P2P investing is meeting a particular demand: Since inception in 2014, NSR has opened 240 accounts on its platform and positioned $95 million of capital for investment advisors.
NSR is targeting a 10% annual net return for its fund. Given that the highest-rated three-year certificate of deposit is yielding 1.4%, peer-to-peer lending certainly is alluring.
“We look at P2P as an alternative fixed-income product that should be added to every retail portfolio,” Brustken says. “It’s a very stable product with a nonvolatile source of cash flow.”
Sang Lee, CEO and founder of DarcMatter, a technology platform that connects issuers and qualified investors in the alternative securities space, says there is a multitrillion-dollar sector to be disrupted in the consumer lending industry alone, never mind the alternative asset class space in general.
“Investors are also increasingly looking towards alternatives as an attractive way to achieve portfolio diversification, mainly due to their ability to cushion against market volatility and enhance alpha generation potential. In fact, 73% of financial advisors in the U.S. and 67% of high-net-worth investors are seeking and interested in alternatives for portfolio inclusion,” Lee says.
To be sure, peer-to-peer lending is already a global phenomenon and growing. Peer-to-peer lending now exists in 50 countries and is practiced by 400 different entities.
Brustken and Lee discussed the opportunities in peer-to-peer lending and direct impact securities exchanges at the 4th Annual Denver Impact Investing workshop produced by Charter Financial Publishing in July. Both of their presentations received a flurry of questions from the nearly 100 people—many of whom were financial advisors—who attended the daylong event.
Impact investing is the strategy-cum-philosophy of investing in companies that “do good” from an environmental, social welfare and corporate governance perspective and also produce market rate returns. From that perspective, they fit into the alternative investment asset class basket, but not so neatly. In fact, there are many questions about how “good” alternatives are structured and whether investments such as P2P loans should be considered impact investments at all:
“Why not go to your local credit union [for better rates]?”
“How do you know what the money is being used for?”
“Why is this impact investing? You don’t know if they are buying clubs to kill baby seals.”
“Can we invest in certain loans, or are they all pooled?”
The questions at the impact-investing workshop rolled on and on—from the general to the technical. And while some of the answers were quick to be had, others were not.
For example, credit unions may, in fact, offer better credit options than peer-to-peer lending groups. And with unsecured capital, there is really no way to determine whether a person might use funds for nefarious purposes—such as buying clubs to kill baby seals. But let’s hope not.
What is extensively known is the profile of the individual to whom money is being lent—so much so that it raises questions about privacy. According to Brustkern, while an individual’s financial profile is detailed to creditors, it is hidden from others on the platform. From an investment perspective, personal data is all part of the due diligence process.
The biggest users of peer-to-peer platforms are trades people, followed by military people, police, firemen and doctors. As NSR proclaims: “trades people and patriots are great investments!”
One way or another, all of these users are alienated from consumer finance. By servicing their capital needs and enveloping them in a more direct process, there is actually an impact and an ethic. That ethic is embraced by many in the peer-to-peer community and is their rationale for dubbing what they do impact investing.
Since 2007, $10 billion has been issued in the P2P sector, touching one million lives. A major selling point of P2P lending is its agnosticism with regard to ethnicity and geography—another reason why proponents call it impact investing. Consumer lenders, meanwhile, have famously been called out by minorities and inner city residents for discriminatory practices. P2P, because it is community based, rises above those kinds of issues.
Still, it is technology that makes P2P attractive to so many.
“The alternative capital markets are plagued by opacity, informational inefficiencies and limited deal selection. However, we’re seeing a proliferation of new developments, such as P2P lending and payment solutions disintermediating sectors traditionally dominated by large financial institutions. It’s only a matter of time before the alternatives market follows suit,” Lee says.
To that end, Lee created DarcMatter. “With DarcMatter, financial advisors are now able to better cater to their clients by having the technological means to access new and portfolio-diversifying opportunities from all around the world,” he says. Those opportunities go beyond P2P, to myriad private issuance of securities—so-called qualified investments.
DarcMatter is an advanced online investment platform that provides investors with institutional-level access to these private investment opportunities. By utilizing proprietary structuring and technology, DarcMatter can provide a “frictionless” process for both investors and private issuers while remaining fully compliant with all current financial regulations. Frictionless, of course, means these are more direct connections between investors and investments, and less third-party involvement means less costs or fees.
It works like this: Investors register to gain access to investment opportunities. DarcMatter then uses a secure and seamless engine to make direct investments, disseminate information and collect profits and distributions from a single user dashboard. DarcMatter posits that by incorporating alternative assets into an investment strategy, there are greater opportunities for portfolio balancing and potential for enhanced investment returns.
But financial advisor participation is key. With direct investing via P2P lending investments such as NSR’s or broader exposure to alternative issuers via platforms such as DarcMatter, advisors are increasingly being presented with unfiltered investment propositions. This greatly increases their value to clients because it is only with sage advice that these investments can be incorporated into portfolios properly. And as clients increasingly desire direct investments, the alternative securities space is rife with opportunity.
How much market or societal impact these investments afford, however, remains to be seen. But what can be easily gleaned by the amount of activity and deal flow that P2P lending and alternative securities markets are seeing is that direct-exchange and P2P iterations are growing exponentially.
New investments of this ilk warrant attention, if not engagement, even if they are old businesses being disrupted and upended.
People always like having alternatives.
