Maria Nadar
July 21, 2022 0 Comment

A comparative view on Debt funds v/s P2P Lending

As we move towards a digital economy and increased financial awareness amongst the newer generation, there has been a change in the backdrop of investment patterns and avenues available to us. Certain existing products, like debt funds, have proven to be more reliable and secure. In contrast, certain risky products with greater returns like P2P lending have also been alluring to a growing number of investors.

What is peer-to-peer lending and how can it benefit you?

Peer-to-peer lending (P2P) has emerged as a more efficient and convenient method of investment. NBFCs with a fintech channel or platform provide P2P lending products. It is similar to crowdsourcing funds in that investor funds are parked in a pool account controlled by an RBI-regulated trustee. With average returns of 10-12 percent and monthly payout options, this class of investments has been gaining a significant share of our portfolios. P2P lending has a minimum ticket size of INR 10,000 and a maximum ticket size of INR 50 lacs.

Why are debt funds a great investment option?

Debt funds, a safer asset class, are low-risk, flexible, and stable investments offered by mutual funds across the country. Their returns outperform those of bank savings and fixed deposits. We can redeem them whenever we want because they are very liquid. These funds range from 1-3 months (liquid funds) to 1-5 years (ultra-short and short-term funds). They put the money into Commercial Papers (CP), Certificates of Deposit (CD), Corporate Bonds, T-Bills, government securities, and other money market instruments. All of these are fixed-income securities.

How to spot the risks in P2P lending

Every asset or investment carries an inherent risk associated with it, remember hearing those disclaimers or seeing those fine print texts in the application forms. Risks associated with P2P lending are the majority of the credit risk, unlike stock markets where you have market fears and volatility scares. Usually, the tenure of lending ranges from 6 months to 6 years which is a short-term investment. Another risk here is that the performance by borrowers of the lending platform directly affects your returns. If a greater number of borrowers default, it’s certain to affect your returns.

If we talk about the firms that do the risk management of these products 5-7% of applications are cleared, pass after a thorough check and receive the funds. And their performance gets them classified as low-risk, medium risk and high-risk customers, which are regularly rigorously monitored as they directly affect the investor pay-out. In the case of debt funds, the investment risk is managed by experienced debt fund managers who have a thorough understanding of the markets and macroeconomic factors that influence debt fund performance.

The Benefits of Debt Funds in a Rising Interest Rate Environment

Debt funds perform best when interest rates are high, as they are now as the RBI raises rates, making debt funds more appealing for investment. P2P lending, on the other hand, is unconcerned about interest rate cycles and market volatility. Certain types of debt funds only invest in government securities that have the highest level of assurance and money safety. And P2P lending is riskier because it targets a specific group of creditworthy individuals.

How P2P Lending Wins Over Debt Funds

P2P lending is a type of crowdfunding that allows people to borrow and lend money without the involvement of financial institutions. In P2P lending, investors pool in money which is then lent to borrowers at an agreed-upon interest rate. P2P lending platforms permit borrowers to apply for loans online and get the money deposited into their accounts within a few days. 

While both debt funds and P2P lending are similar in many ways, there are some key differences between them. One of the most significant distinctions is that debt funds are managed by professional fund managers, whereas peer-to-peer lending platforms are managed by algorithms, which means that debt fund managers may charge fees for their services, whereas most P2P lending platforms are free to use.  Moreover, the interest rates on debt instruments can fluctuate over time, whereas the interest rate on a P2P loan is fixed. Overall, P2P lending offers several advantages over debt funds, making it an attractive option for investors seeking to earn interest income.

When we compare the tax aspects, in P2P lending, the transaction is between two individuals, so TDS plays a role. The interest income is taxable. However, debt funds are tax-efficient too. For example, savings and FD interests are taxed as per the income slab of the customer. Capital gains from debt funds with a holding period of 3 or more years are taxed at 20% whereas the capital gains for holding periods of 3 years or less is 20.90%.

Conclusion 

P2P lending in India is at a very early stage, whereas Debt funds have been seen as a matured product category that has gained trust over the years. But with inflation, around the 7-8 % range, the returns from debt funds of the 6-7.5% range are not that great, but in times when bear markets are on, debt funds are a relatively safer haven to put your money. We cannot just start focusing on return while investing, so having a limit check on our percentage allocation to risk classes like P2P lending should be in place. Diversification among our investments has many long-term benefits for sure.

Say if you have a portfolio with components like stocks, fixed deposits, and mutual funds with an average return of 15 percent. P2P lending as an investment can add more value to your portfolio, and debt funds can give you stability. So choose a combination with your risk capacity, but do not have bias restricting you from investing.