The rush of institutional money into the P2P lending market has arguably been the big news for the movement this year and it’s clear that professional investors are now responsible for a fair proportion of the growth in overall lending. But with the Innovative Finance ISA expected next April, the sources of funding for P2P lending are getting both wider and deeper. Interesting times, and particularly interesting when you start to think about the implications of Funding Circle’s plan to list its own fund on the stock exchange later this year, with an initial plan to raise £150m of fresh capital. I suspect this move could have some big long-term implications; it certainly opens up some intriguing possibilities.

 

 

Funding Circle’s plan is to create a publicly listed investment trust, the Funding Circle SME Income Fund, which according to the initial reports will operate as a passive vehicle, investing in most if not all of the loans advanced via FC’s UK and US platforms. It will levy no management charge and no performance fees (other than the standard 1% a year that all investors pay to access the market) and will not use leverage (cheap borrowed money) to enhance returns to its investors, unlike most of the other listed P2P funds. Funding Circle says it expects the fund to offer an annual yield of about 6%-7%, against the 7.5% average gross yield after bad debts and platform fees that it advertises today.  

 

 

Assuming it goes ahead, it seems likely to achieve a number of things:

 

 

• It will set a baseline expectation of what the unleveraged yield from a well-diversified basket of largely unsecured SME loans should be – in much the same way as Funding Circle’s minimum bid levels in each risk band effectively set investor expectations for what the returns should be across the different types of borrower. Funding Circle’s size and dominance, especially in the UK, will increasingly set the benchmark for the wider market

 

• It will let investors “buy the market” in one move, thereby providing an ideal way into Funding Circle for new lenders who want instant diversification and none of the bother of assessing individual borrowers or having to set up and manage Autobid. With ISA money starting to flow from next April, the fund could easily become the favoured way into Funding Circle for less experienced retail investors (and their financial advisers). ThinCats is thinking along somewhat similar lines with its Thincats Lending Club vehicles, which pool exposure to ten loans in each £1000 unit the investor buys. Funding Circle has long preached the benefits for borrowers of diversification and this fund follows where the wider investment world is leading – towards highly-diversified, low-cost, passive strategies.

 

• Assuming this fund does become the preferred route into Funding Circle for less experienced retail investors, it could give the platform much better control over the flow of ISA money on to its market. ISA investment is traditionally very seasonal with a huge peak in March and April and much smaller flows for the rest of the year. Extreme seasonal variations like this present a big challenge to a loan market that needs to keep the supply of money in good balance with demand at all times. But if ISA money flows in mainly via Funding Circle’s listed fund, the platform can issue new shares in the fund when it likes, enabling it to better suit its own liquidity needs and smooth out the seasonal peaks and troughs, rather than facing a wall of cash every spring. This is where the closed-end structure of an investment trust is such a huge help to a market like Funding Circle – unless it issues new shares, everyone who puts money in has to take the place of someone else who sells out, thereby keeping the total quantity of money managed by the fund constant and preventing a tsunami of cash from swamping the market

 

• The new fund will offer retail investors access to the market via any Stocks and Shares ISAs, thereby removing the need to go to the bother of opening an account with Funding Circle, setting up an Innovative Finance ISA and working out which companies to lend to, or setting up Autobid. This potentially removes any pressing need for Funding Circle to become an ISA provider itself in order to be able to launch a dedicated Innovative Finance ISA. I’m not clear how much money there is to be made by becoming an ISA provider and it might make more sense in the long run to launch this fund and work within the existing ISA infrastructure. Eventually, an independent ISA provider might well set up an IFISA that will allow investors to lend on a range of platforms through one account, but that’s still some way off. In a market where each P2P platform will have to provide a dedicated ISA for its investors, the Funding Circle fund looks like a neat way to sidestep the headaches of dealing with the IFISA, welcome though its introduction undoubtedly is.

 

• If the great majority of retail investors choose to access Funding Circle via its fund, they effectively become an institutional investor themselves and so are at less risk of being disadvantaged as small investors competing against professional fund managers with greater clout because they control greater sums. I suspect Funding Circle will keep the option open for serious DIY investors (and institutions) to pick individual loans for themselves, but over time I think most money is likely to access the market passively via this fund (and others).

 

• The fund provides Funding Circle with so-called “permanent capital”. There cannot be a sudden rush of liquidity off the platform when the money is provided by a closed-end fund such as this because, as already explained, for every seller of a share in the fund there has to be a buyer. So ensuring continuing liquidity becomes that much easier. Big private equity managers such as KKR have listed closed-end funds that give exposure to their investment portfolios via the stock market in recent years for similar reasons – permanent capital is a very useful thing to have at your disposal, not least because it pays permanent fees. In this case, the fund guarantees Funding Circle revenues of at least £1.5m a year on the basis of a 1% fee on the initial £150m of capital.

 

• Finally (for now), the quoted fund could in time become Funding Circle’s de facto secondary market, effectively replacing the secondary market it currently runs. The existing secondary market has had good levels of liquidity up to now but has never faced a serious test during times of stress. It would make much more sense as Funding Circle grows for it, in effect, to use the stock exchange as its secondary market rather than running one itself, not least because the stock market is likely to remain far more liquid in times of stress.

 

 

This fund launch raises a lot of interesting possibilities for the future shape of P2P lending, many of which will also apply to GLIF’s planned fund launch, which will give retail investors diversified access to its wide range of business lending platforms, some of which are not open to retail money by other routes. The more I think about it, the more it seems that the structure emerging here – an online marketplace lending platform linked to a dedicated closed-end fund – could become standard in the maturing alternative finance business, at least for the larger platforms. The cost of maintaining a fund listing will make it impractical for small platforms to have dedicated vehicles, but for the leaders the advantages of operating this way look compelling.