According to the mainstream media, investors have only one option when it comes to increasing yield – invest in blue-chip stocks. There is, however, an emerging alternative in the form of peer-to-peer lending that increasingly deserves to be in the conversation.
The quest for better yield is only becoming more challenging for SMSFs. Interest rates are at historic lows and market expectations are that they will stay low in the long term.
ATO data reveals that by far the two largest SMSF asset allocations are cash and term deposits (25.6 per cent) and listed shares (30.2 per cent). But the underlying trend is towards more listed shares and less cash. June 2013 was the last time SMSFs held more cash and term deposits ($143 billion) than listed shares ($141 billion). As at June 2016, the allocations were $159 billion for cash and $188 billion for listed shares.
There could be many drivers for this trend, but seeking better yield is likely to be the main catalyst. The risk and return equation for blue-chip stocks does, however, make for interesting reading. Between December 2014 and March 2015, SMSFs increased holdings of listed shares by $18 billion, from $171 billion to $189 billion. It was during this time the S&P ASX 100 Index was just under 5000. By late 2015, the index was heading back towards 4000 and by September 2015, SMSF holdings of listed shares decreased by $13 billion to $174 billion.
The approximately 20 per cent fall in the ASX 100 in only a few short months during 2015 was a harsh lesson for SMSFs and judging by the rapid decline in listed share ownership between June and September 2015, a good number of SMSFs realised some significant capital losses.
I have of course focused on the negative and long-term investors in the share market may point to overall capital gains. The point is not the winners and the losers, it is the exposure to volatility and risk.
But what of the dividend yields? Taking three well-known stocks as an example, National Australia Bank has a dividend yield of 7.40 per cent a year, but the share price has moved within a 33 per cent range over the past 12 months ($24 to $32), Commonwealth Bank of Australia yields 5.95 per cent a year, with a 21 per cent range in the past 12 months and Wesfarmers yields 4.37 per cent a year, with a 19 per cent range. Meanwhile, the BHP-Billiton dividend yield is 1.96 per cent and over the past five years the share price has fluctuated within a 166 per cent range ($15 to $40).
The moral of the story is simply this: even the highest-profile blue-chip stocks have very volatile share prices. The best reward for this risk is about 7 per cent to 8 per cent a year and maybe some capital growth for those lucky enough to pick the market or young enough to ride out a very long cycle.
The greatest barrier to peer-to-peer lending being part of the yield conversation is investors becoming familiar with and confident in the underlying risks. For those not familiar, peer-to-peer lending involves investors effectively stepping into the shoes of a bank and lending money directly to borrowers. The borrowers can be people and they can be businesses. If the borrower doesn’t make payments, then the investor could lose capital, just as a bank does when loans go bad.
The aim of lending is simply to earn enough from ‘performing loans’ to offset any losses from bad loans. For example, if a lender earns an average of 13 per cent a year on $100,000, but 2 per cent of loans go bad, then the annual return should be $13,000 less $2000 – net $11,000 – with no overall capital loss. The equation is never that simple, because loan portfolios are rarely perfectly balanced. An overweight position in a bad loan can be just as capital destructive as an overweight position in a bad listed stock.
Lending is, however, rarely as volatile as stock markets. The Australian Prudential Regulation Authority is currently reporting that both personal and business defaults are under 2 per cent of the total loan books of banks in Australia. After the global financial crises in 2008, personal lending defaults increased to over 2 per cent and business lending defaults to over 3.5 per cent. A material increase, but nowhere near the high numbers of the share market.
The peer-to-peer lending industry in Australia is relatively new and therefore has little track record to point to. But in the United Kingdom and United States, the industry is around 10 years old and default outcomes have been comparable to and in many cases better than banks. Our task over the coming years is to prove our risk of loss is both predictable and stable. Once investors can quantify the risk, the investment case looks compelling, with platforms offering returns ranging from 7 per cent a year to as high as 18 per cent a year. It will therefore only be a matter of time before peer-to-peer lending becomes a major part of the yield conversation.