When will private banks offer marketplace lending investments?
James Levy, founder of Clearwater Private Investment, argues there are several benefits to P2P and marketplace lending that institutional investors should take note of.
A recent headline in the financial press proclaimed, “Morgan Stanley´s VIP Private Banking Clients Finance Spanish Oil Major Repsol at Bargain Rates”.
What occurred was the following. Global investment bank Morgan Stanley underwrote a large bond issue for Repsol (rated BBB-, negative, that is, on the verge of becoming a junk bond) and then sold this same bond to Morgan Stanley´s own private banking client base. As Repsol is deeply indebted and facing an uncertain future, the company has had difficulty tapping the professional institutional bond market in recent years.
The solution? Morgan Stanley sells Repsol bonds to their own captive, much less sophisticated Private Banking clients who are desperately seeking yields on their fixed income investments in the ongoing near zero (or even below zero) interest rate environment for traditional fixed income and bank deposits.
What is the compensation for Morgan Stanley private banking clients for assuming Repsol risk over the lifetime of the bonds until they reach maturity several years from now? Less than 1 per cent per year. Not a very generous risk adjusted return, especially considering the very poor rating of the Repsol bond. It is difficult to understand how the army of investment strategists, analysts, and portfolio managers of all kinds in the employ of Morgan Stanley are not able to offer their own wealth management clients in their Private Banking division a more worthwhile alternative.
As I stated over two years ago in my April 2014 article in Alfi News, “Escape from the Matrix: Alternative Investments and Investment Advisors”
"Something is wrong, very wrong, at the heart of the investment advisory industry. Many of my most astute colleagues, who like your author have more than two decades of experience in private banking advising high net-worth clients, know in their hearts that something has gone awry in our trade. Far from improving, the situation is worsening, and the very tools of our profession (deposits, stocks, bonds, annuities) are increasingly inadequate to build a portfolio for our clients that will satisfy their fundamental needs for capital preservation plus reasonable, low volatility growth over time."
Since this article was published, a huge variety of alternative investments in the form of marketplace lending instruments have become available to investors to provide consistent, attractive returns through loaning money to consumers and business in a multitude of different ways.
These alternatives range from direct investment through any of dozens of platforms, to purchase of unit trusts, to investment in a wide variety of specialized funds offering investors excellent risk adjusted returns through consumer lending, small business lending, invoice finance, trade finance or real-estate finance bridge loans.
Though all of these alternatives for investors in marketplace lending are now more consolidated with longer track records than they were when my article was published in 2014, private banks continue to ignore marketplace lending as an alternative source of returns for their wealth management clients. Instead, they continue to offer these clients traditional corporate bonds, such as the Repsol bonds mentioned earlier with a return of less than 1 per cent per year.
What are the specific advantages of marketplace lending investment over traditional fixed income investments? I highlight the following:
1) Attractive, consistent returns across marketplaces and strategies:
For example, the Orchard US Consumer Marketplace Lending Index measures the performance of investment in direct online lending to US consumers through the leading US based platforms.
The chart below tracks the performance of this index since 2011. Despite the scary headlines concerning problems at US platforms such as Lending Club, what we see is years of steady, predictable, attractive performance between 6% and 8% per year.
In the United Kingdom, the Liberum AltFi Returns Index measures the returns for investors generated from marketplace lending through the leading UK platforms.
Again, we see years of steady, attractive returns for savers, averaging between 5 per cent and 6 per cent per year.
LARI index returns since April 2006
Source: AltFi Data
Finally, in Continental Europe, since the first day of 2012 my own firm has maintained a model portfolio of Luxembourg-based marketplace lending funds (including specialised funds focused on consumer lending, business lending, invoice finance, trade finance, and real-estate bridge loans) that has given investors similar steady, attractive returns with an average return of over 5 per cent per year.
In each case, whether based on US, United Kingdom or Continental European experience, the available returns for investors from marketplace lending are far and above that which can be obtained through investment in traditional fixed income, and have demonstrated an admirable consistency through time.
Diversification of Risk.
Marketplace lending by its very nature lends itself to broad diversification. Those who invest directly through platforms are encouraged to invest smaller amounts in a large number of different loans in order to reduce the risk to their returns from the failure of any particular loans. Investors in Unit Trusts or Luxembourg Sicavs focused on various aspects of marketplace lending benefit from having their investment diversified across hundreds, and often thousands, of individual loan transactions that constitute the fund at any given time.
2) Self Liquidation
As marketplace lending loans typically have much shorter maturities than traditional fixed income investments, an investor can normally recover their investment through maturity of the underlying loans. In the case of invoice lending and trade finance, loans are typically between 60 to 90 days, while real-estate bridge finance in rarely longer than a year. These shorter maturities are an enormous advantage when compared to holding longer maturity traditional bonds as a fixed income investor.
A marketplace lending investor can recover a significant part of their investment simply through maturities and interest payments over a period of just a few months, as opposed to traditional fixed income investors who must pay fees and commissions to sell their bond in the secondary market if they need to recover their principal. Furthermore, at times of distress in the financial markets, the bond markets may offer very poor prices for the bonds in the secondary market. Investors may have no choice but to sell their bonds at prices well below that which appeared on their last statement from their private bank.
In short, investing in marketplace lending offers so many advantages to investors in terms of steady predictable returns, diversification and self-liquidation, that it can be only a matter of time until wealth managers at Private Banks begin to integrate marketplace lending instruments into their advisory toolkit. The continuing growth and consolidation of a multitude of marketplace lending alternatives for investors will eventually force financial advisors to “escape from the matrix” of their traditional tools of deposits and bonds. Savers and investors worldwide will benefit when this transition finally takes place.