Investors should diversify their P2P investments to minimise losses due to defaults
While investors in peer-to-peer (P2P) financing must be prepared to accept the risk of default by the investment note issuers, they can be rest assured that platform operators are doing their utmost best to prevent such incidence from occurring in the first place.
Undeniably, the higher returns from investing in P2P financing comes with higher default risk. While investors acknowledge the existence of such risks, P2P platform operators have the obligation to reduce such risks as part of their due diligence and risk assessment process.
Funding Societies Malaysia, the largest P2P financing platform in the country, has stringent credit assessment and proactive debt recovery processes to minimise the risk of defaults and the potential losses arising from them. For example, Funding Societies regularly communicates with all small and medium enterprises (SMEs) to remind them of their repayment dates to ensure a smooth collection process and that all repayments are made on time.
In fact, SMEs who anticipate difficulties with meeting their future repayments are strongly advised to reach out to Funding Societies’ team to discuss potential remediation actions in order to minimise the financial strain on the SMEs cash flow whilst minimising the loss to investors, according to Funding Societies Malaysia CEO Mr Wong Kah Meng.
“First and foremost, we will reach out to SMEs who missed out on their repayment to understand the nature of the delinquency as this will pave way to our next course of action,” he points out.
“Our priority would be to strike a balance between minimising the loss to investors and providing constructive solutions to SMEs, thus enabling them to better manage their finances to meet their repayment obligations.”
Defaults and business failures are a very natural part of running a business and this is especially true for SMEs as they either face concentration risk (given that their size limits them to serving only a small number of customers whom they are dependent on) or are generally less able to withstand seismic market shocks in the event of a downturn.
“We therefore empathise with SMEs facing financial difficulty and do our level best to propose alternative repayment structures to help them tide over challenging times,” stresses Wong.
For uncooperative SMEs, Wong says Funding Societies Malaysia is left with no option except stepping up collection efforts through legal action. This is a vital step to ensure SMEs are aware of their obligations to make repayments on time and to protect investors’ interest.
A default happens when SMEs fail to meet their repayments obligations within a stipulated time frame, typically within 60 to 90 days of their repayment date. Nevertheless, even after an SME is classified as defaulted, the obligation for the SME to meet their repayment remains and collection efforts against the SME will continue.
“Above all else, we perform site visits, interviews, as well as having access to credit bureau information (CCRIS) to support our due diligence and risk assessment of SMEs,” he adds.
To date, the processes put in place by Funding Societies Malaysia has been effective in minimising the impact of defaults given that the P2P financing platform has only posted a default rate of less than 1% thereby allowing investors to earn superior risk-adjusted returns.
To further mitigate the losses from defaults, Wong urges investors to diversify into as many deals (issued notes) as possible.
“Diversification means distributing your funds across multiple investment opportunities,” he explains. “In general, the more diversified your investment portfolio of P2P financing, the less likely you are to experience large losses to your investments.”
For example, if an investor invests RM10,000 into one SME which in turn defaults, the investor could potentially lose all of his RM10,000. But if the same amount is invested across 10 SMEs at RM1,000 each, the investor will be less impacted from defaults as it is less likely for all 10 SMEs to default compared to the single SME defaulting scenario.
In order to simplify the investing process for busy individuals, Funding Societies has pioneered an Auto Allocation feature where investors can set their investment parameter (including investment per note, preferred interest rates, investment tenure and industry choice) that will be automatically invested into notes that fit those parameters.
This technology-driven solution has helped many investors to easily create a hassle-free and diversified portfolio.
Currently, there are more than 20,000 registered investors with Funding Societies Malaysia. Of this total, 70% are millennials which highlights the interest of the younger generation in P2P financing as an investment option.
P2P financing connects SMEs with investors through an online marketplace, thereby increasing access to SME financing. In exchange – by investing into SMEs – investors could earn returns up to 14% p.a. which is greater than returns offered by fixed deposits, bonds, and other traditional investment instruments.