Recently, Squirrel have joined the ever growing list of InvestNow funds on offer. Squirrel offer services in mortgage broking, and peer to peer lending and borrowing.

Anyone who invests is obviously a lender and that is the aspect I am interested in here. The fund on offer is called the monthly income fund and invests in peer to peer loans. Basically you would be lending your money to Squirrel borrowers who are taking loans for residential properties, and you will be paid a monthly distribution.

The fund invests in three classes of loans:

1/. Construction loans: For those wanting to borrow for buying land or building new. These loans tend to be for a period of 2 years.

2/. Home loans: For those buying second hand properties. These loans are typically up to 7 years. Maximum loans tend to be capped at no more than 80% of the value of the property.

3/. Personal loans: Other lending for things such as deposits or renovations. These loans are typically up to 7 years.

All loans are secured over physical property. In the case of the personal loans, only loans over $20,000 are secured by personal property. At the moment, approximately 65% of the personal loans are secured against other borrower assets.

The fund will predominantly invest in the first two: Construction and home loans. The fund will invest in a wide range of loans from a wide range of borrowers. Some loans will be fractional; some will be the full loan.

The loans are predominantly on floating interest rates, with a small proportion on fixed rates. The return objective of the fund is to provide investors a return of 4% above the OCR (Official Cash Rate) after fees, but before taxes.

The fees of investing in this fund through InvestNow are 0.65%.

What I am interested in writing about, as so often I am, is the risk of any investment.

Squirrel have allocated this fund a risk rating indicator of 2 on scale of 1 to 7. 2 being low risk. Even the Smartshares global bond fund has a risk indicator of 3, and I would argue that mortgage lending to one segment of the market (borrowers) in one segment of the economy (housing) carries significantly more risk than a bond fund investing in governments and local authorities in a wide range of countries with over 80% of the assets scoring an A or better credit rating.

Squirrel can point to the fact that they have never missed a payment to an investor and that they have a reserve fund to help manage risk, but as we all know, history is no means a predictor of future returns. In fact, since Squirrel has started, house prices in NZ have been on an extraordinary run. Their investments have not been tested by either a slowdown or decrease in house prices, nor an extended recessionary environment. The reserve fund currently sits at just $1 million which is not a lot when you think about it in the context of their current loan book value of $55 million.

The reserve fund is not a guarantee, nor is it insured.

Although the fact that most of the investments are on floating rates is sold as a positive, as it allows your investments to keep up with inflation, there is a risk to the downside too. Higher interest rates increase the likelihood of borrowers defaulting as they are already on higher rates than the banks. With floating rates, borrowers also have the ability to pay loans off more quickly. This isn’t good for your returns as it means your monthly income returns for that investment loan will stop early too.

The other thing I touched on is that residential property is not a very diverse investment. Within a lot of stock and bond funds, you can invest across a wide range of companies, industries and countries which can help to spread your risk. No such luxury with this fund. Property is not at all diverse as an asset.

Lastly, it can be quite illiquid. 30 days to get your money out is a long time. This period can be up to 6 months at the fund managers discretion too.

Squirrel have said that they help to manage these risks by lending only to credit worthy borrowers and by having a reserve fund. But someone is credit worthy until they are not. Sometimes, the most credit worthy person can’t survive an economical or personal disaster.

I am not saying anything Squirrel don’t already know. They put these risks and more in their PDS which I attached earlier, in the sceond paragraph. It’s quite the list for a risk indicator of 2.

This article points out a lot of the downsides, but it can be a great fund for someone to add to their portfolio if you are interested and ok with the risk/reward ratio. The fund can potentially provide some solid returns given the right environment and investing timeframe. It’s exciting that new products are coming onto the market, providing investors with more options.

But my opinion, and reason for pointing out the risks, is the stated risk indicator score of 2 and minimum investment recommendation of two years is too low for a fund of this type. I put the likes of cash and term deposits in the 1 and 2 categories on the risk scale. I would have thought a longer investment timeframe is necessary here. If a well diversified, high credit rated, global government Smartshares bond fund is a 3 on the risk scale, that should give some context for your own decision and comparison to come to your own conclusions.

The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here