This article first appeared in Wealth, The Edge Malaysia Weekly on August 29, 2022 - September 4, 2022
News headlines such as “Investors seeking return of RM50 million worth of funds from company” make me wonder, yet again, why such incidents surface every few months.
Just like how our health is sometimes neglected with excuses of “It is fine to finish another packet of chips” and “Healthier living can start next week”, many of us seem to apply the same logic to investing. All investments come with risks, hence the possibility of losing money will always be there. So, it may be fine to “indulge” in risky investments, sometimes, for short-term pleasure or gains.
However, it becomes a problem if the investments are made in companies and activities that cannot explain the means of the promised returns. Without a thorough understanding of what drives the investment yields, it may not be wrong to regard the action as gambling rather than investing.
Instead of “investing” in schemes that lack clarity on how returns are generated, the money could be better used to fund genuine micro, small and medium enterprises (MSMEs). Easily 700 of such businesses could be “saved” in the aftermath of the prolonged pandemic — and investors could enjoy positive returns.
Even someone as young as 18 years old with just RM50 of spare cash per month can fund MSMEs in the country via legitimate peer-to-peer (P2P) financing platforms approved by the Securities Commission Malaysia (SC) to begin his/her secured online investment journey, which is altruistic at the same time.
P2P platforms in the country complement the banking industry by providing alternative funding avenues to MSMEs, which are viable but may not meet the criteria of the banks. These could be new enterprises, businesses with insufficient collateral or track records, or have funding needs beyond working capital.
The reason P2P platforms have been introduced by the SC is to provide opportunities for the public to become bankers themselves to help MSMEs in the country grow. Whether or not the approved funding is disbursed to MSMEs depends on the people, because only businesses (or borrowers) that achieve a minimum of 80% of the approved amount receive the funds.
Another important part of the SC’s guidelines is a ceiling rate for the interest that can be charged, and changes in rates are periodically monitored to prevent “predatory financing” that may affect the profile of MSME borrowers, which are termed as issuers in P2P financing because their funds are raised through the issuance of legally binding promissory notes to investors. Thus, the people are essentially investing in “mini bonds” raised by MSMEs for clearly stated purposes and terms, which are transparent to all parties involved.
The SC also requires all P2P platforms to have a back-up service provider to take over the platform and ensure that the integrity of all notes issued are intact in the event of a voluntary or involuntary exit of the platforms.
Besides this, all of the investors’ money is kept by an independent trustee, which eliminates the worry of misappropriation of funds by the platform operators. Thus, the only key risk that investors need to consider is repayment risk or defaults in repayments.
As consumers seeking healthier options for our daily consumption, we have learnt to read food labels. The very same must be done before investing. Investors must check who the people behind the platforms are because they are the first line of defence, responsible not just for sourcing businesses in need of raising funds but also for the evaluation and pricing model of notes hosted.
Next would be the track record in terms of the consistency of hosting notes and the unique number of issuers, given that one of the key success factors in P2P investing is “true diversification”.
The word “true” is stressed because investing in 10 notes by one issuer, and 10 notes by 10 different issuers obviously comes with extremely different risks. Should the issuer default on one note in the former situation, it is likely that the other nine notes would end up in default as well. Hence, losses may be greater than envisaged if this concentration risk was not taken into account from the start. If it is the latter situation, because the businesses are owned by different people, the likelihood of one failure affecting the rest is rather remote.
Another important check would be how transparent the platforms are with information. The more dynamic the information made accessible, the simpler the investment journey. This refers to both up-to-date information on the performance of the platform as well as on investors’ own portfolio that can be readily downloaded for further analysis.
Generally, the returns on investment generated by each P2P platform would not be markedly different, mainly because of the ceiling rates set by the SC. However, depending on the tenure of the notes and frequency of repayments to be made, there could be distinctive differences in the returns as well as risks.
Put simply, short-term financing may offer higher returns on investment, but if the repayment is to be made in a lump sum (called bullet repayment), the risk would also be higher. Monthly repayments offer a higher ability to compound one’s earnings and redeploy the capital for repeated investments, which may even result in higher yields at lower risks. That is because the investments continue to diversify into new notes over time. Investors should also look for additional frills that may further mitigate risks such as guarantees and protection offered by the operators.
As per the latest statistics, investors, mostly the public, had in less than five years helped 4,655 MSMEs obtain business funding and support despite the pandemic. The industry, which recorded its highest disbursement in 2021 and 2022, is set to break this record. However, the potential of the “power of the people for the MSMEs” still has a long way to be realised, despite the involvement of the government via the Malaysia Co-investment Fund (MYCIF) since 2019.
MSMEs form the backbone of the economy. If in whatever little ways of our own we can support their growth, we become not just investors seeking returns to grow our nest egg but also an active part of nation-building.
Investors should be aware that repayment risk exists in notes that have not been fully repaid, and their repayment period could be as short as three months to as long as three years. Notes that are being actively repaid may still face repayment risk due to many unforeseen circumstances.
Investors are also required to pay taxes on interest income, as stipulated by the Inland Revenue Board. However, this could be tricky if P2P investors pay taxes based on the interest income received during the year of assessment, but the notes they invested in default in the following year of assessment, which could wipe out all of their gains or more.
This gives rise to the question of whether income derived from P2P financing should be exempt from tax since its intention is to help MSMEs’ growth and job creation and retention.
Perhaps, as how parents may reward their children as a form of motivation, incentives to encourage this healthy investment behaviour should be introduced, not just to increase the rate of participation but also to promote sustainable, long-term participation.
Kristine Ng is co-founder and ex-CEO of licensed peer-to-peer financing platform Fundaztic and a former banker
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