Summary: Over the 20 years until 2014, Australia has been one of the few low-inflation nations where term deposits and online savings accounts have paid 3 to 5% (after inflation) and since 2008 been guaranteed by the government up to $250,000 per Authorised Deposit-taking Institution (ADI).
However, very low interest rates have arrived in Australia and are set to stay for at least several years and possibly decades (due to lower growth and inflation plus high household debt). Even those like me who had high-paying 5 year term deposits at 6-7% interest will find they've all matured by 2017. The top paying 5 year term deposit is now 3.5% and the best on-call savings accounts are around 2.87%.
When government-guaranteed term deposits are paying 5%+ and inflation is less than 2%, there is less value in shifting this part of your investments to higher risk options just to get a couple of percentage points more yield. But with safe bank returns at only 3%, it is worthwhile considering shifting some savings to investments offering much higher returns as long as the risk is not excessive. This is where P2P lending for Australian retail investors comes in as it offers returns (before uncovered defaults) of around 9% for 5 year lending.
Personally, I have chosen to switch most of my maturing term deposits to P2P lending with RateSetter Australia, mostly in the 5 year market with returns of around 9% (not counting defaults the Ratesetter provision fund can't cover, so far there haven't been any). This investment isn't covered by the government at all and wouldn't be bailed out, is actually a Managed Investment Scheme not the equivalent of a term deposit, and there are various other risks that it is vital that any investor properly understands.
Due to the significant amount I've invested, and my desire to recommend RateSetter Australia to friends and blog readers as a potential investment if they consider the risks acceptable, I plan to collate answers to various queries on the risks versus returns in this post.
Gain: ~ 2% to 5% more yield on savings that are essentially capital-protected apart from when there is a spike in loan defaults (e.g. a major recession) - in this case you'd want to reduce exposure and also ensure the extra yield you collected was compensating you for any potential capital losses.
My Situation: As of April 2018, I had around 55% of my savings in RateSetter Australia's 5 year market earning around 9%. So far, with no defaults not covered by the Provision Fund. This proportion is not recommended for most people and is due to my higher risk tolerance, ongoing monitoring of loan quality and defaults, and capacity to go earn income in well-paid employment if some very low probability major capital loss event occurred. This proportion will reduce to ~30% as I start investing in passive index ETFs and long-term LICs, or if bank term deposits spike above 6%.
Referral Bonus: There are occasional periods when referral bonuses are offered. During such periods you can use my referral link to sign up and get $100 after investing $1000.
Details:
Note this post is an ongoing work-in-progress and much more remains to be written about the risks, limiting your investments to worthwhile returns, ways to better protect yourself, and my own experience with P2P and Person-to-Business lending in Australia.
Where does P2P lending fit among worthwhile investment options?
The best P2P lending platforms should be considered among all of the other worthwhile investment options available to Australian retail investors.
In my view, worthwhile investment options include:
- High-interest online savings accounts (UBank, Rabodirect, ING Direct)
- 5 year govt-guaranteed term deposits if paying at least 3% more than the RBA cash rate or over 7%
- Balanced options in the best performing, low-fee industry superannuation funds (especially if on higher tax rates or able to salary sacrifice)
- Very low fee index funds and index ETFs to diversify exposure to stocks, bonds, property. E.g. Vanguard Australia - Individual Investors
See: > Start maintaining a more effective investment portfolio
Examples of investments options I don't consider worthwhile:
- Most managed funds (fees too high, active management rarely outperforms in the long run)
- Hybrids unless a sophisticated investor (see why here, and here)
- Debentures (return doesn't jusitify risks)
- Direct bond ownership (concentration risk isn't worth it)
- Most Managed Investment Schemes (too risky)
- I consider most P2P and Person-to-Business lending platforms in Australia too risky for significant investment for various reasons such as: not achieving economies of scale, higher risk of failing or closing, insufficient default provisions, competing for higher risk borrowers, principal focus on business lending, etc.
About P2P lending in Australia
SMH
> P2P lending offers investors 10% returns but what's the catch?
> RateSetter allows retail investors to lend to business
Money Morning
> P2P Lending — What It Is, Who’s Doing It, and How You Can Get Involved
Switzer
> Peer to peer lending – so much hype!
Bond Advisor
> Term Deposits – Past, Current & Future Trends
When The Path Forks
> Vanguard Wholesale Funds
About the risks of lending on RateSetter Australia
RateSetter Australia
> Peer-to-peer lending - Why RateSetter
> Peer-to-peer lending - Lending markets
> Peer-to-peer lending - Risks
> Peer-to-peer lending - Statistics
> Peer-to-peer lending - Provision Fund
> Product Disclosure Statement (pdf)
> Lending FAQs
I don't have the time to provide detailed discussion of the risks on this blog but recommend:
- Essentially you need to do your research sufficiently such that you have an understanding of how their business model actually works and how it changes going forward. For example, RateSetter Australia pools investor funds simply by term period (from 1 month to 5 years) but it's completely open to them to collect varying borrower rate premiums (thus borrower risk can vary significantly), set varying borrower terms, or lend the money into structured products (e.g. mortgage trusts).
- Reading the PDS whenever updated as RateSetter Australia is continually expanding who it lends to (businesses, clean energy, mortgage trusts, etc)
- Reading news about RateSetter Australia in publications like the Australian Financial Review.
- The main aim of my ongoing monitoring of its business model is to ensure the don't drop down the borrower quality spectrum too far, and don't have too much of the loan book exposed to assets I'm wary of (e.g. residential mortgages, some small business lending).
Note that coverage ratio has dropped from 182% to 168% from Sept 2016 to Mar 2018. For comparison, RateSetter UK has a target ratio of 125-150% and as of 17 Mar 2018 its coverage ratio was 116%.
Note that the 168% coverage ratio equals the provision fund total divided by the estimated bad debt total. If the coverage ratio got below 125% I imagine RateSetter Australia would bump up its lender charge to increase the provision fund and if it got close to 100% I imagine it might consider actions like temporarily suspending interest coverage while still maintaining capital coverage till the ratio improved.
I expect that eventually RateSetter Australia's 100% provision fund payout history will be tested but I expect there to be early signs in the coverage ratio slipping (with time to contact them regarding any intended steps to bump it up) and later signs with reminders the provision fund is not unsurance and even announcements of potential actions like suspension of interest payments from the provision fund.
What are the minimum RateSetter rates in each market I should accept given the risks?
Given P2P lending in RateSetter has non-neglible risks of not receiving all of your principal back, everyone should decide for themselves a minimum risk premium they are willing to accept (over the essentially risk-free rate they can get).
For example, when I had government-guaranteed, 5 year term deposits paying around 7% interest, I was not a significant lender on RateSetter as my initial risk premium was around 4% and I couldn't lend at 11%.
But, as of Dec 2017, with 5 year term deposits paying a maximum of 3.5% and my risk premium dropping to ~2.5% (based on 3 years experience) in normal bad loan conditions it means I would accept RateSetter 5 year rates above 6%. Given I'm getting around 9% there is a large buffer currently.
In determining your minimum required rates for the available markets consider:
- Current term deposit rates and comparable RateSetter rates
- The fact the RateSetter listed rates are a bit higher than what you'll actually receive given that repayments don't hit your account immediately and can sit in your holding account or on-market for periods
- Your liquidity needs. I don't put a high value on having quick access to most of these funds and, in fact, expect term deposit interest rates to remain very low for several years, so actually prefer 5 year terms to the shorter-term markets. Principal is also returned monthly and early repayments are common so once you have a significant sum invested you'll actually always have plenty of money being paid out each month that you could stop reinvesting if need be.
- Remember to optimise yield on your money you need to try and re-invest quickly at the best available rate (or set up automated reinvestment) or take your money out and put it in an online savings account till ready to invest a larger lump sum (I put mine in UBank USaver). The holding account and on-market funds pay zero interest.
Essentially, I don't see value in lending in the 1 Month, 1 Year or Green loan markets. I do all of my current lending in the 5 year market at the best rates regularly available that don't involve having my funds sitting unmatched in the market for more than a few days.
As of Dec 2017, that means lending at between 8.9% and 9.3% in the 5 year market.
The Rate History page indicates what recent rates are like. Based on this you may set your large lump sum minimum rate (e.g. ~9%), update your automated Reinvestment settings or accept the market rate, or choose to occasionally transfer repayments out till there is a rate spike and then reinvest.
Tips on minimising risks if lending on RateSetter
I will summarise tips here and expand on them when time permits.
- Break up the funds you lend into parcels to avoid concentrated default exposure to only a few borrowers. E.g. If lending $20,000 total you might wish to break this into four $5,000 lending orders which you can submit on different days so that you don't end up matched to a single borrower of a large amount.
- Breaking up the lending funds into parcels also allows you to move them independently to different rates in order to get matched quicker or at higher rates.
- Ensure you set up a weekly auto-withdrawal from your holding account directly to a high-interest savings account like UBank USaver otherwise you are losing interest as RateSetter pays zero on funds in the holding account or on-market.
- If you wish to reinvest repaid funds, enter your automated reinvestment settings. The RateSetter market rate is usually a good default choice. If you find it is matching lower than you could get by managing your own rate then do it yourself but this will require logging in at least weekly. More commonly you may find that it can sometimes take several days longer to get matched using the market rate compared to setting your own rate 0.1% lower. So if you have a large lump sum to invest you can always manually lend just below where most of the funds are sitting.
Further Info:
Choice
> Peer-to-peer lending
AFR
> Latitude Financial pledges to grow lending responsibly and profitably
> CEFC invests $20m with RateSetter's 'green loan' marketplace
> Mortgage trust sector has nearly doubled over the past year: SQM Research
> Fintech business lenders to self-regulate
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