Marketplace loans (MPLs), also known as peer-to-peer loans, are an exciting new asset class offering institutional investors and wealth managers a number of benefits not found in traditional fixed income products.
However, because they are typically issued to retail consumers and private businesses, each loan is relatively small. For a manager looking to invest tens of millions, this means monitoring and reinvesting thousands of individual loans (all with short maturities and frequent cashflows) – a daunting task for any organization. In addition, building a truly diversified portfolio requires investing in multiple P2P platforms, which further complicates the management process.
There are two primary strategies for addressing these challenges. First, institutions and wealth managers can purchase one of several commercially available software packages that are designed specifically for marketplace loans. Secondly they can work with a professional asset manager who specializes in marketplace loans. In this article we’ll examine the two different options.
DIY: Using a Vendor Solution
The primary benefit of implementing a vendor system to manage your MPL portfolio is that you have full control over your investments. You can implement an automated trading program tailored to your specific strategy, and of course you can always perform manual overrides.
Most systems allow you to base your trading decisions on a wide range of parameters – major P2P platforms like Prosper and Lending Club include dozens of fields in their API framework. This gives you a rich source of data from which to develop your analytics, and the platforms are designed to support high-speed algorithmic trading so you can easily execute your strategy.
However, going with a DIY approach means that you need to develop reliable strategies for each P2P platform, which of course is challenging and generally costly. Our experience consistently reinforces that each platform requires a unique model, even similar platforms like Prosper and Lending Club.
Another downside to the DIY approach is that the trading software requires a material setup cost to get started. Even modern solutions that are cloud-based and user friendly need to be configured (and tested) to work with your strategy.
Working With a Manager
There are several benefits of working with a manager. First, they handle the entire investment process so you don’t have to concern yourself with any of the aforementioned practical challenges. They monitor the portfolio, reinvest the cash flows, implement the software, and handle all reporting responsibilities.
Perhaps more importantly, P2P investment managers develop their own investment strategies for each lending platform, which is a huge value-add. For institutional investors and wealth managers who are not P2P specialists, it is a significant undertaking to build, test, calibrate, and maintain quantitative strategies that will reliably generate alpha.
Another benefit is that managers are able to provide access to marketplace loans that are not otherwise accessible. For example, most international P2P platforms are not open to foreign investors, even though they tend to deliver higher risk adjusted returns than their domestic peers.
Some specialty P2P asset managers have been able to overcome these barriers and build relationships with lenders who are willing to work with them directly. This is a major value add, as the managers engage the platforms in a thorough due diligence process, evaluating underwriting practices, navigating regulations, and aggregating exposures into a cohesive portfolio. The manager also adds value to the originator by de-risking sources of funding and, where relevant, streamlining investment processes.
Likewise, many new P2P platforms will not provide APIs that integrate with commercially available portfolio management software until they’ve reached a certain scale. But asset management firms have the resources to build the API connections themselves, which again creates access for clients that would otherwise not be possible.
Of course, if you choose to work with a professional manager, you need to find the firm that best aligns with your own strategic objectives. Is the fund too risky or too conservative? Is the geographic mix compatible with your existing portfolio? The evaluation process is time consuming, as there are many different options (and more managers are entering the market as the MPL space matures).
The Bottom Line
While there is little doubt that marketplace loans are a great complement to a core fixed income allocation, determining the best way to access the market depends on the needs of your specific organization.
If you have ample resources, DIY is an excellent option that provides ultimate flexibility and control. If, however, you are limited in your bandwidth and/or budget, working with a manager is probably the best option.