Getting good returns from peer-to-peer lending
Tan Jee Yee 
If you’ve been keeping an eye on developments in the fintech world, the term “peer-to-peer lending” (or P2P lending) would have caught your attention.

Online P2P lending platforms have surged in popularity, especially among start-ups. Even Malaysia wants in on the action. You might, too.

The concept of P2P lending is simple. The platforms help connect people who want to borrow directly from other people, thus bypassing stringent and rigid requirements of banks. At its core, it’s no different from borrowing money from a well-to-do neighbour, friend or family member to start a business.

What is different is that the aspiring entrepreneur can borrow from a pool of lenders, for the amount he needs.

This is especially appealing to businesses seeking short-term financing, and smaller establishments that have difficulty qualifying for loans from the bank. The borrower would still have to repay the principal with interest over a set period of time.

It’s not just businesses and entrepreneurs that are benefiting from P2P lending platforms – investors are as well. They earn interest from the loans they provide.

This method of investment has been gaining momentum of late, with many claiming the investment has less volatility, low correlation and yields much higher returns than other fixed-yield investments.

The key question is whether P2P lending can be considered a good investment. What are the risks?

A fast-growing market
P2P lending platforms have grown significantly since the idea first emerged back in 2005, when Zopa – the largest P2P lending platform in the UK – surfaced. A finding by Transparency Market Research suggests the global peer-to-peer market may be worth US$897.85 bil (RM3.86 tril) by 2024, from US$26.16 bil in 2015.

It’s also the financial service that is growing faster than others, with China’s market being by far the largest and most dynamic, with more than 4,000 providers as of last year.

This growth hasn’t escaped the attention of the authorities in Malaysia. Last year, it became the first Asean country to regulate P2P financing platforms when the Securities Commission (SC) appointed six parties to run their respective platforms.

“The fact that it’s seeing strong international growth and with Malaysia leading the way in ushering it in this region, I would say that P2P makes for a very solid, stable investment,” says Anson Loke, an entrepreneur and investor who has invested in P2P lending in the past two years.

“When more platforms are introduced in Malaysia, P2P’s viability as an investment will surely increase.”

The reasons for investing in P2P lending are many, but if we just look at it in terms of returns, it becomes instantly appealing.

In P2P lending, one’s returns hinge entirely on the risk of the loans you are providing. Through risk assessment, P2P lending operators will assign an interest rate for the underlying loans. To recap, the interest from the loan – after deducting any service fee for the platform – will be your approximate annual returns.

Let’s look at Lending Club’s risk-interest rate as an example. Under the US-based P2P lending platform’s definition, loan grade classified as “A1” represents the category of loans with the lowest risk, hence the lower interest rate (5.32%). On the other hand, loan grade G5 represents the category of loans with the highest risk, hence its whopping 30.99% interest rate.

“So, depending on your risk appetite, you can gain more returns compared to most fixed-yield investments,” says Loke. The average rate of return for established lending platforms like Lending Club has been consistently good, too. The service registered an average return of 6.85% across all risk levels from 2007 to last year, even after deducting service fees, and late and defaulted payments.

Another good reason to give P2P lending a try is that getting into it is easy. Platforms like Lending Club, for example, allow people to put out loans as low as US$25, meaning the entry level is suitable for most. The fact that loans are segregated into different, easy-to-understand grades means people can more safely decide how much to invest and the risk they are getting into.

“You don’t need a lot of industry know-how to get started, and the risk grades are easy to understand,” says Loke, though he advises doing more research before getting started, especially on understanding how the P2P lending system works and the risks involved.

P2P lending platforms also offer more stable returns, Loke says, because unlike stock funds, stocks and bonds where you receive only a distributed income typically every quarter, P2P lending allows you to receive a monthly payment. Lenders usually receive their repayments and the interest after two months of the loan being taken. “It’s a stable monthly income, in a sense, which is more consistent compared to other investments,” Loke adds.

Getting into P2P lending has the added benefit of helping the SME community, especially if you invest in platforms that cater to local entrepreneurs. “It’s a way for people to invest in their own economy and help SMEs get started,” Loke says.

“Not everyone can be an angel investor, but it’s very easy for people to help crowdfund a business, and almost everyone willing to spend the money can do it, even in small amounts. You can truly make a difference.”

Chan says people need to be aware that P2P is not without risks

Defaulters and risks
P2P lending investor David Chan hopes people become more aware that P2P lending isn’t as riskless as people make it out to be. “Like all investments, P2P comes with its own risks. You can stand to lose a lot,” he says, adding that people need to manage their expectations and also consider their own risk appetite.

For starters, borrowers may actually default on their payments, leaving you high and dry. It’s also important to know that not all P2P platforms guarantee loans, so if a borrower defaults on a loan you’ve invested in, don’t expect the P2P platform to pay you back from its own pocket.

“These platforms, like the two largest in the US (including Lending Club), may do their own work to recover money from delinquent borrowers, but it’s also noted on their websites that loans are not insured or guaranteed,” says Chan.

According to Lending Club, loans across all risk levels had registered a default rate of 0.5% over the first to third quarter of last year. The default rate for each risk level can be seen in table 2.

What’s more, some platforms include collection fees to pay the platform for its efforts to recover the defaulted money. “These fees are typically disclosed on the platforms’ websites, but not all of them are very clear,” Chan says.

In fact, most P2P platforms gain revenue from fees charged to both borrowers and investors. “Most lending operators get a 2% cut from your profits. So, if the interest rate is 10%, you effectively get 8% in returns,” he says.

Stick to the reputable
The good news, according to Chan, is that most major platforms are safe to invest in, including Malaysia’s own Funding Societies, which provides P2P financing to local SMEs. Proper P2P platforms don’t actually hold your money within the organisation – all of the loan money is entrusted with an independent and licensed trustee, meaning the platforms have no authorisation over it.

Still, Chan says it is important for people to invest in only reputable platforms. “There are money games that target people hoping to invest in P2P lending. It’s much better to stick with reputable, regulated platforms.”

There is a challenge for Malaysians hoping to hop onto P2P lending – local (and regulated) platforms are limited. Last year, the SC announced six P2P financing platform operators out of 50 applicants, which include the Funding Societies. “Not all of them are in full operation yet, so local investment choices are a tad limited, for now at least,” Chan says.

This means that people who intend to dive in would have to invest in platforms from other countries, which pose their own challenges. Lending Club, for instance, requires an American bank account.

Investing in other countries carries its own set of risks. “China’s P2P market recently had a big crackdown, as there have been many scams. Sometimes, such information is not so apparent to all of us. Investors need to take extra care,” Chan explains.

Freelance financial adviser Lee Chin Lien says people should also take note that P2P is a new frontier, and it’s unclear what will happen to it during major economic downturns.

“P2P critics have said it is difficult to gauge how well the loans will perform during a recession. When the market is stressed, how well will the borrowers actually perform?” he asks.

“Of course, all manner of investments are risky to begin with. I’m not against investing in P2P lending, but everyone needs to know the risks involved and how and when to play it safe,” Lee adds.

Diversity is key
Both Loke and Chan say diversity is important. “The saying of not putting all your eggs in one basket rings true here,” Loke says. The better approach is to build a portfolio of multiple loans.”

For instance, if you have RM5,000, Loke says it’s better to split it into five portions for five different loans. “If one defaults, you will not lose all of your investment. The gains are the same, but by spreading out, you lessen the risk of losing all of your eggs,” he elaborates.

Chan says it’s also good to diversify your investments into different loan grades, depending on one’s risk appetite. “For example, I have my money spread out to different grades, which gives me varied returns.”

It’s also good to diversify not only within one platform, but across different ones as well. “Not only are you lessening your own risk, you’re also benefiting from different interest rates.”

In fact, even the lending platforms are touting the benefits of diversifying your investments. Lending Club released charts that illustrate how diversifying an investment equally across multiple loans – especially across hundreds of them – can drive even more solid returns. Investors with more diversified accounts have experienced generally less volatility and more solid returns than those with more concentrated holdings.

The challenge here is that to achieve a healthy amount of diversification, quite a bit of money is required, says Chan. “Spreading out your portfolio also means spreading out your returns, so if you want higher returns that may mitigate your losses, you would want to spread out to as many loans as possible. But that would need a lot of money,” he says.

Details of borrower
Still, Chan believes that people can start slow, just to get a feel of the waters. “Remember, you can give out even small loans, as small as US$25. Say you have RM5,000 – you can spread it out equally to about 50 loans, and use the returns to beef up your portfolio and expand your investment. It may sound slow and taxing, but that’s how most investments work anyway.”

Loke says investors need to be more selective about who they give their money to. Most major platforms will list down as much details of the borrower as possible. “This includes the sort of venture or business he is getting into, his background, and even the terms of the lending like whether the payment comes monthly or not. You should scrutinise the details as much as possible.”

Aspiring P2P investors should also know that they don’t have to fund 100% of a loan. “You can invest in partial loans, like contributing a smaller amount of money. The platforms can pool contributions from other investors to meet the borrower’s needs,” Loke adds.

Both Loke and Chan say investors should not be too hasty in cashing out all of their returns. “You should play the patient game and reinvest your returns, and also by building up a larger portfolio. Remember, the most successful P2P lending investors have hundreds, if not thousands, of loans across different platforms,” Chan points out.

P2P lending will only become more prominent in the coming years. In that case, there’s no real need to rush our investments in it. If you’re interested to give it a try, there’s no harm starting slow.

Difference between P2P lending and crowdfunding

Often, peer-to-peer (P2P) lending and crowdfunding are mentioned together, and some may consider them one and the same. After all, both allow people to directly invest in start-ups and businesses they are interested in. However, the two platforms are fundamentally different.

In P2P lending, investors lend to people or businesses, which will repay them with cash plus interest over the duration of the loan.

Crowdfunding, on the other hand, is less straightforward. There are two types of crowdfunding – reward-based and equity-based.

Reward-based crowdfunding would be what platforms like Kickstarter and Indiegogo provide. Here, people help fund a project or product, and in return they receive the product when it’s done along with other perks and rewards depending on how much they spent. Reward-based crowdfunding isn’t really an investment, but closer to a form of sponsorship, as there is no financial return.

Equity-based crowdfunding works more like a conventional investment in shares. Here, entrepreneurs or early-stage companies offer shares in the business in exchange for upfront investment loan. As an investor of equity-based crowdfunding, you will essentially own a small part of the business, letting you reap the benefits if the company does well.

This is opposed to P2P lending, where investors only get the interest of the repaid debt.

This article first appeared in Focus Malaysia Issue 240.