An update to LARI calculation methodology

By Sam Griffiths on 8th August 2016

Since the launch of the Liberum AltFi Returns Index in March 2015 we have continually monitored and reviewed the index calculation methodology. The methodology that we adopted remains unique and was designed specifically with the challenges and idiosyncrasies of the UK marketplace lending industry in mind. The aim was to develop an index that was a true reflection of the return that an investor could achieve by investing in marketplace lending.

An update to LARI calculation methodology

The index is calculated on a cashflow basis. The calculation takes every cashflow (interest, principal, chargeoffs and recoveries) each day and divides that by the outstanding principal to reach a daily return figure. The rapid growth rate of the industry means that the average age of loans in the portfolio is less than it would be for a mature portfolio. This means that the portfolio experiences proportionately fewer defaults and, as a result, a purely volume weighted index would overstate achievable returns. The LARI output is therefore time weighted with an equal amount of notional capital deployed each quarter. For those interested in finding out more, you can review the full methodology here.

In a recent review of the index we discovered that recoveries of loans in old cohorts, with very little principal left outstanding, were having a disproportionate impact on the total return. Some recoveries were contributing a larger positive impact on index return than the initial negative impact that the default had caused. As a result, the recovery would have a disproportionately positive impact on returns.

In light of this, AltFi Data has added a factor to recoveries such that they can never have a larger impact on the index return than the impact of the initial chargeoff. The overall impact of making this change is a 77bps reduction in the prevailing industry return. We have also restated the index history applying the new methodology in order to enable a true like for like comparison. The chart below shows the difference between the old and new methodologies. The aim of the Liberum AltFi Returns Index is to replicate the return that an investor can achieve by investing in marketplace lending. By making this change we are confident that we come even closer to accurately representing that return. 

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