Investing in alternative finance funds has become increasingly popular in recent years for several reasons. First, is the opportunity to gain outsized returns in an environment that has been hard-pressed to deliver sustained growth in recent years. The second reason is the relative safety of these funds when compared to riskier investments such as corporate bonds or commodities.
As if this wasn’t reason enough to make money by investing in alternative finance funds, there is a third reason – market expansion. According to research by the U.K.-based Merchant Money, nearly 56% of small businesses were unfamiliar with the various forms of alternative finance. If anything, this points to an opportunity for future investment in alternative finance funds.
If you are involved in business finance then you will understand why these funds exists. Large banks are not well equipped to service small businesses. This is largely due to their cost structure as the time and expense to process one, $5 million loan is the same as processing one, $50,000 loan. However there is more profit, and to a certain extent less risk, in the larger loans.
This has created a large, underserved market, which is primed for disruption. In the U.S., alternative lenders are expected to gain more than 20% share of the market for small business lending by 2020 and the sector is the fastest growing financial product on the market. In addition, alternative lenders are constantly coming up with new products to serve the small business market. As such, it is highly likely that they will soon become the lender of choice.
As mentioned, the combination of higher returns on investment and lower risk is another reason why alternative finance funds are attracting the attention of investors. Whilst some of the players in this space focus on equity through crowdfunding. A large number of funds are focused on debt finance. In 2015, the amount lent by the funds eclipsed $55 billion.
This is not to say that these investments are not without risk. In fact, this is part of the reason for the higher than average returns. However, the attraction of debt funds has to do with the nature of the investment as debt instruments take first position in the case of default or insolvency. In fact, White & Case, a leading global law firm, noted, ‘investors take confidence from low default rates, and high yield and leveraged loan defaults are well below historic averages.’
Whilst this investment class does offer promise, it is ultimately up to the investor to review the options and then decide which alternative investment fund is the best fit for their portfolio. In the U.S. many of these funds are privately held through hedge funds, private equity funds, or even family offices.
One example of an alternative investment fund is Mulligan Funding in San Diego which operates a working capital finance fund. Since 2008, they have worked with more than 50,000 small businesses across the country.
As many of these funds are privately held, due diligence prior to investing is critical. This means performing a thorough review of confidential placement memorandums and other deal documents. In addition, you should talk to current and past clients to gauge their satisfaction with the lender. You may also want to talk to competitors as this is a useful way to get discrete information about the industry.
In addition, you should vet multiple funds in this space before making an investment. This will give you an opportunity to benchmark the performance of each fund including returns, investment thesis, and other variables. Another point of interest should be how these lenders structure their offerings to customers.
Many of the loans in this space are repaid in months, not years, and some deduct against the principal due on a daily basis. While this structure is common, it is not used by every alternative lender. So it is a good idea to understand how their core processes are structured before making an investment.
Investment in alternative finance funds can be a great addition to a portfolio. Basically, you are using your money to help small businesses across the country while getting a decent return on your investment. However, these investments are not without risk. As such. proper time and energy should spent to learn the ins and out a target fund before making an investment.
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