P2PGI has delivered good NAV growth versus the index – but is this a fair comparison?
In MW Eaglewood’s most recent quarterly newsletter they compared their NAV performance to the AltFi Data Marketplace Lending Returns Index – as replicated below.
The AltFi Data Marketplace Lending Returns Index represents the return that an investor would have achieved from investing in an equal time weighted exposure to every loan originated by the 4 UK platforms (Zopa, Funding Circle, RateSetter and MarketInvoice) who together consistently make up over 70% of UK monthly origination. This makes the AltFi Data Marketplace Lending Returns Index an excellent guide to what an investor might have achieved by investing directly and a useful benchmark against which to measure the NAV performance delivered by the manager of P2PGI.
But when making this comparison it is important to be aware of one particular caveat - the effects of seasoning.
First, let's take a quick step back and review why seasoning is important. Consider the chart below showing a typical default curve. In fact this curve is the aggregated cumulative default rate, for all loans originated in the 2012 cohort, across all 4 of the constituent platforms that make up the AltFi Data returns index.
We can see that whilst the cohort is unseasoned it has very low default rates and that the bulk of the defaults occur only as the loans mature. Specifically, we can see that there are almost no defaulted loans after less than 6 months, but defaults then rise sharply in particular over the subsequent 18 months. As a result of this effect returns on unseasoned vintages are relatively high. However, returns decline as portfolios season and defaults occur, before stabilizing as recoveries begin to moderate that effect.
The conclusion to be drawn from this is that age distribution, or seasoning, matters when comparing portfolios. In fact, if the seasoning distribution is not the same then it is not possible to make a like-for-like comparison. In the light of this it is interesting to observe the differences in age distribution between the index and P2PGI’s portfolio.
For the AltFi Data Marketplace Lending Returns Index the seasoning distribution is skewed towards unseasoned loans. This is a natural consequence of the equal time weighted exposure that the index represents. The Index portfolio has been constructed by making an equal notional investment each quarter into what are predominantly amortising loans. As a result the index has a steadily diminishing exposure because as loans age they repay.
However, it is difficult for a fund to achieve such a distribution because deployment is not even across quarters. In fact, to mitigate cash drag, deployment inevitably intensifies as assets are raised.
Thus, P2PGI has a notably different exposure than the index. Specifically, it has a relatively low exposure to loans aged below 6 months, and a higher exposure to loans of between 6 and 24 months old. This reflects the profile of deployment whereby cash was rapidly deployed post launch to mitigate the dilutive affect of un-deployed capital.
By overlaying the two charts the difference becomes clear. P2PGI has a much higher exposure to the worst part of the default curve – the exact period when defaults are rising but before recoveries are beginning to mitigate that effect.
It is for investors to decide how this informs their investment decisions. But it is important to keep in mind when investing directly that platforms offer exposure to unseasoned loans where the future performance of the vintage is unknown. Alternatively listed funds offer the opportunity to invest in seasoned portfolios - in some cases at a material discount to par. This raises interesting implications both as to the relative value of each fund, and to the level of discount to NAV on offer for portfolios of different age distributions.
A snapshot of an ageing portfolio can prove unflattering. In some cases, unreasonably so.