Peer-to-peer lending is an increasingly popular form of investment that enables borrowers and investors to connect in an online marketplace. Within peer-to-peer lending there are many loan types available to lend, from consumer and business loans to mortgages, loan types differ across platforms and each come with their own risk profile. Experienced investors know that often the higher the return means the higher the risk, so it’s important to weigh up the risk vs return before committing to an investment.
In the current long term low interest rate environment, new investors are being attracted by headline interest rates, however it’s important to dig deeper to fully understand the detail underneath the headline rates.
A simple way to measure risk is through the volatility of an investment, the smaller the volatility, the lower the risk (although note that risk and volatility are not the same thing). To illustrate, below we look at the monthly returns of a Landbay investment compared with a FTSE100 investment over a 2-year period from August 14 to June 16.
How does a Landbay investment compare with other investment options?
Average return for FTSE100: 0.3% Standard deviation: 3.2% Volatility: 1.1%
Average return for Landbay: 0.3% Standard deviation: 0% Volatility: 0.1%
In the above example we can see that a FTSE100 investment delivers a monthly average return of 0.3% and exhibits a high standard deviation (3.2%). This shows how there is a tendency for the returns to rise or fall significantly over a short period. Because it fluctuates so often between a negative and positive return it should be viewed as a high risk investment - as the return is unpredictable. With 11% volatility for a FTSE100 investment during this period, the return would depend heavily on when the investment was made and withdrawn.
If we compare this with an investment with Landbay, we can see this delivers a very consistent monthly return with zero standard deviation, which means that a return in any given month did not differ from its 2-year mean of 0.3%.
However, volatility is only one indicator of the risk affecting a security and so it’s important to remember that a reliable past performance might not guarantee future stability.
How to measure the risk to my investment?
The Sharpe ratio is the industry standard calculation for measuring a risk adjusted return, it helps investors to calculate whether the investment risk is worth the possibility that the return can be lost, enabling them to analyse how much great a return they can get in relation to the additional risk taken to generate that return.
Any Sharpe ratio greater than 1 would be considered as ‘acceptable’ to ‘good’ by investors. A ratio greater than 2 is considered ‘very good’, and a ratio of over 3 is considered ‘excellent’. Essentially, the higher the ratio the better.
Below is a comparison between the Sharpe ratio for the same FTSE100 and Landbay investments based on the historic performance if the same 2-year period (Aug-14 to Aug-16).
FTSE100 Sharpe ratio: 0.06
The monthly return is calculated as a difference between closing price at the end of each month
Landbay Sharpe ratio: 4.6
Although actually loss rate is 0%, an assumption has been made around the annual expected loss rate of 0.10%
It’s important to bear in mind that a ‘good’ (or more favourable) Sharpe ratio, as well as return on investment, depends a great deal on when the investment has been made and when the return has been realised, as well as how volatile the market was during that period.
If i invest in P2P can i ensure my money is protected?
Peer-to-peer lending platforms use a range of methods to protect investments. Landbay has 5 securities in place to protect your investment, including the credit assessment and scoring of borrowers, anti-fraud checks, diversification of investments, a provision fund, and secured loans. Read our risk statement for more information about the precautions we take to ensure your investment performs well.
Are P2P investments protected by a body?
Landbay is fully authorised and regulated by the Financial Conduct Authority (FCA), investments with Landbay are not covered by the Financial Services Compensation Scheme (FSCS). We provide investors the opportunity to invest on a secured‐basis directly against residential property loans. We recommend you seek professional, independent financial advice if you are in any doubt as to whether investing with Landbay is suitable for you.
When you choose a peer-to-peer lending platform like Landbay, you can invest from as little as £100 and begin earning interest on your investment within 24 hours of receipt of cleared funds, subject to mortgage investments being available. We automatically diversify your investment across multiple buy-to-let mortgages with terms of up to ten years. Find out more about how direct lending with Landbay works.