Alternative finance models and the rise of the retail investor

This article originally appeared in IR Magazine and is written by Rachel Carroll, global head of investor relations for Edison Group

World Bank estimates alternative market could account for $90 bn of investment by 2020

Asset management is facing a challenging and turbulent period. Advances in technology, a prolonged low-interest-rate environment, the increase in independent or retail investors assuming a pivotal role in managing their own assets, and growing concerns over fees and performance are challenging traditional business models.

Emerging from the volatility of a rapidly changing financial services industry is an alternative finance market supplying debt finance to small and medium enterprises (SMEs), venture finance to start-ups and, more recently, equity finance to publicly traded companies. Last year alone investments via alternative finance vehicles in the UK grew by 84 percent to £3 bn ($3.9 bn). Globally, the total is closer to $34 bn, with the World Bank estimating this could grow to $90 bn by 2020.

Technology is the key disruptor, offering low-cost, transparent and flexible investment advice to growing numbers of retail investors seeking to increase their investment returns. Peer-to-peer lending remains the largest alternative finance model by volume in the UK, representing 13.9 percent of new bank loans to SMEs in 2015, according to the UK Alternative Finance Industry Report 2015 put out by Nesta Impact Investments.

Since 2008 there have been onerous capital requirements placed on banks that make it difficult to lend to SMEs. Peer-to-peer lending vehicles, which do not operate within this regulatory framework and require lower capital reserves, are therefore an attractive alternative for SMEs seeking debt finance. Algorithms, which enable credit decisions and underwriting to take place in a matter of minutes, allow retail investors to monitor portfolios on demand.

Originally a platform for creative and early-stage businesses, crowdfunding has also exploded in recent years, evolving beyond reward-based returns to issuing debt and equity for fully commercial propositions, and with record valuations. This has worked particularly well for consumer brands such as BrewDog, where customers also act as brand advocates, socializing within their own networks and helping to increase market share in a virtuous circle.

With crowdfunding platform SyndicateRoom being granted intermediary status earlier this year, and Seedrs and Crowdcube becoming more actively involved in IPOs, there is evidence that UK retail investors are already starting to follow the US model of becoming an ever-more important constituent of company share registers.

Counter-intuitively, it is not just wealthy, tech-savvy millennials embracing a new age of tech-driven investing. A persistently low-interest-rate environment has drawn criticism of annuities from pensioners given the relatively small returns they can achieve on their savings. With the ability to now access their entire pension pot, older individuals are looking to maximize returns. An analysis by the Association of British Insurers suggests that drawdowns in the first year of pension freedom totaled £4.3 bn. This trend is set to continue, particularly following the August interest rate cut, a move welcomed by alternative finance platforms in anticipation of an influx of new investors seeking higher returns.

How should IROs respond?

Unlike professional investors, retail investors’ access to information is limited. As part of a broader engagement strategy, IROs should consider what communication channels can effectively reach and influence this audience. Given the inherent challenge in communicating with such a vast and diverse group of investors, an effective strategy is to use the digital channels investors themselves use to build a profile and control the message.

Independent research providers are an effective means of communicating the investment thesis in an appropriate format, with the advantage of open-format distribution to as many investors as possible though email and positioning on major financial portals. This can be supported by company webinars, executive interviews on investor-facing news sites and trading platforms, and well-co-ordinated media campaigns to the financial press supplemented with highly targeted retail events, preferably to a prequalified audience.

Communication should be clear, concise and compelling, with complexities in technology or the business and financial model simplified and clearly explained. A good proportion of retail investors will look beyond the pure financial return to the social and environmental impact of a company’s operations, which should be considered in investor communications.

As global equity-related commissions continue to decline and the sell side shifts toward more liquid, larger-cap stocks, a focused retail strategy will not only help improve the liquidity profile of early-stage PLCs and those tightly held by institutions, but could also more meaningfully contribute to fundraising and the activity of public share registers in the future. With continued contraction in the traditional sell-side and buy-side models, IROs should pay close attention as this unfolds and be mindful to stay ahead of the curve in tapping this potential and growing pool of investment capital.

Rachel Carroll is global head of investor relations for Edison Group