The benefits for those putting up the money to lend

In the last decade, we have witnessed rapid growth in the alternative lending space, with the creation of new business models opening up the range of alternative lending products available.

Two key factors have driven this growth.

Also Read: Singapore-based lending platform Helicap raises US$5M to go to Indonesia

Firstly, the credit squeeze which followed the global financial crisis of 2008 highlighted the lack of options for borrowers who were forced to seek different sources of credit.

Once this process started, the gradual return of the banks to lending was not sufficient to restrict these new methods. In effect, a process of disintermediating the banks began.

Secondly, the advance of new technology has enabled new ways of connecting borrowers and lenders and fuelled this process of disintermediation.

The rise of big data and artificial intelligence enables efficient and extremely accurate risk-profiling processes, therefore democratising a core competency that the banks traditionally held as their own.

The route to obtaining a loan has traditionally been via the banks, which have been able to dominate the market due to their access to low-cost funding via deposits.

Alternative lending, however, has developed in many forms, including:

Peer-to-peer (P2P) lending. Often used as an umbrella term for various kinds of alternative lending, P2P is essentially a marketplace model for connecting unsecured borrowers with investors looking for a return. The practice has attracted a lot of criticism though, and consumers have faced issues with scams and insolvency (particularly in China), so it is now, rightly so, highly scrutinised by regulators.
Crowdfunding. Mostly associated with entrepreneurs seeking start-up funding for specific projects, in return for the promise of a reward. This is often a guarantee of receiving the start-up’s product at a discount, for example.
Equity crowdfunding. Aversion of crowdfunding where, again, start-up enterprises can tap early-stage funding in exchange for a share of the business. This stake will bring with it a say in the management and direction of the business, as well as a share of profits and/ or dividends.
Microfinance. Another umbrella term that covers a number of options, microfinance tends to target the financially underserved and, more recently, small business owners, enabling them to become more self-sufficient. The industry is growing rapidly, and it has been lauded as a valuable tool to empower disadvantaged individuals and communities.
Invoice trading. A method that enables small businesses to access funds by selling their invoices at a discount, either to individuals or, increasingly, to institutional investors.
Balance sheet-lending. A more established practice than other alternative types of lending, and one of the more commonplace ways to get a loan. A private company offers a loan to businesses or individuals, and keeps this on their balance sheet, setting up a repayment plan with the client. This has proved to be a well-trodden path to offering the MSME sector access to essential credit and is a sector we see growing enormously and responsibly.

In Asia, the alternative lending sector has experienced rapid growth.

Also Read: Go-Jek announces partnership with 3 P2P lending firms

The total transaction value grew 24 per cent between 2018 and 2019, to US$224,000.6 million.

It is expected to show an annual growth rate of 11.3 per cent, resulting in the total amount of US$343,214.1 million by 2023.

The highest value globally is in China, with a total transaction value of US$222,404m in 2019.

The alternative approach

However, it is worth noting that a series of scandals in the P2P lending space in China triggered a crackdown by regulators in 2017.

Anyone considering investing in alternative lending, and not just in P2P lending, need to ensure they are protected by a regulation that will ensure high standards of conduct by intermediary platforms and offer a level of protection for their funds.

It also pays to be strategic when considering alternative lending as an investment, and we recommend taking the following into account:

Ease of access: The increasingly-commodified vehicles available via reputable investment advisors mean you don’t have to research opportunities and engage directly. You can do this via an alternative credit fund, in much the same way as you may gain exposure to gold, equities, alternative investments or bonds. Managed funds can also outperform the broader alternative credit space.
Diversify: As with any high-return/ high-risk investment, consider using alternative lending to add some upside to your portfolio. Retain sufficient ‘safer’ investments to mitigate the risks and create a balanced return.
Correlation: Another benefit of diversifying in this way is to introduce a source of earnings to your portfolio that is uncorrelated with the more traditional markets. This can add stability and insure against volatility in markets.
Access different opportunities: Alternative lending investments can give access to openings in industries, geographies and borrower types that not only increase your chances of tapping new growth opportunities at an early stage.
Tax benefits: microlending may not offer monetary profits in all cases, but it may earn you a favourable tax relief for the amounts you lend. To leverage this, ensure you seek a reputable microlending platform.

Returning to returns

As a relatively new form of investment, alternatives don’t have a deep track record like bonds or equities to give you a long-term historical view.

However, there is some data available.

According to Willis Towers Watson, managers who include alternative credit as part of a broader strategy indicate a return of around 9.5 per cent, with lower volatility.

Across the broad U.S. alternative credit landscape, investors’ average return is 4.4 per cent, making alternative lending significantly more profitable than a savings account or other low-yield investments.

In Asia, reliable independent numbers on investment returns are harder to find, but for those prepared to look, some indications are available.

Depending on the nature of the borrower and tenor (duration) of the loan, Southeast Asia based P2P lending company Funding Societies shows a return in the range of 8-15 per cent a year. Investors willing to offer higher-risk loans can access yields of 10-12 per cent.

In some markets like India, returns can reach 18-26 per cent, according to lender Faircent.com.

Also Read: 4 ways fintech is disrupting the lending industry

Don’t ignore the risks

As with any investment, of course, there is always risk involved and any assessment of a potential opportunity need appropriate research and due diligence applied.

In the alternative space, regulation is still catching up with the development of the technology, but not all platforms or products are yet subject to oversight.

Lenders are making use of big data and artificial intelligence to better manage risks and we take an innovative approach that ensures that borrowers are vetted correctly, and capital awarded appropriately and responsibly, but this can never be eliminated.

The risk of borrowers defaulting should also be taken into account. Higher returns tend to reflect a higher risk of default.

As we saw in China, we still see some platforms in the market that are set up by bad actors whose intention is to take the money and run.

Doing your due diligence is critical to ensure you choose a platform that is legitimate and has proper oversight.

There is no doubt that alternative lending offers exciting new options and potential returns for investors.

The field is diverse, with providers ranging from start-ups to the largest names in the financial services business.

But as with any investment, the fundamental principles apply: do your research, look for reputable providers, be suspicious of predicted returns if they seem excessively high, and don’t forget to diversify.

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