Marketplace lending is a hot story in fixed-income investment circles. Young companies like LendingClub, Prosper, SoFi, and others have succeeded by democratizing the financing of loans with technology. And some have created accessible “peer-to-peer” marketplaces for loans that benefit both borrowers and investors.
But is investing in the hot marketplace lending space right for you? It all depends on what you’re seeking.
Marketplace lending represents a radical departure from traditional lending. The business has made headlines due to its breakneck pace of growth and because it benefits both sides of the table. Borrowers have tremendously benefited from the speed, convenience and lower rates available from marketplace lenders, and have experienced a greater degree of financial inclusion, even with bad or no credit. They may also receive better rates, and more efficient, timely loan closings.
On the other side, investors in the marketplace lending space have the ability to make direct investments in previously inaccessible debt classes, including both secured and unsecured. Previously, this access was only available to wealthy investors and to institutions. New technology allows investors to purchase fractional notes, allowing for the potential for greater investment diversification. Higher yields than publicly traded fixed-income products are particularly attractive, as is the opportunity to manage risk appetite by customizing a portfolio..
Altogether, marketplace lending has been a fantastic innovation in the fixed income space, but when selecting what to invest in, a good option might be to focus on risk-adjusted yields.
The first, and best known, marketplace lenders currently exist in the unsecured consumer debt space. This market has provided very good returns, but at higher rates of default than other types of debt. Worse, in the instance of a borrower default there is likely little to no recourse for the investor. In these cases, a substantial part or all of one’s principal is most likely gone. It’s a risk that should be acknowledged, and no one can say for sure what will happen to the unsecured consumer debt market in an eventual financial downturn.
Integrating risk in measuring the yield from an investment is an excellent option, especially for certain types of investors, like those that make up much of the baby boomer generation. After all, the US is seeing a record number of people turning 65. Many of those who are approaching retirement age or are current retirees are not necessarily seeking “home run”-returning fixed income products, but instead seek value in products that are safe, that can outpace inflation and that provide superior yields, beyond inflation, that they can live on without eating into their principal. Marketplace lending is evolving to address this historically large segment of the population.
Further innovation in the collateralized debt markets is creating a safer, happier medium. When one risk-adjusts the yield for an investment, one can account for both default rate and value of any collateral. If a borrower defaults on a loan with collateral, investors can liquidate the collateral to gain back much of, if not all, the principal. As a result, this segment of marketplace lending provides a safer product that likely appeals to more conservative investors while continuing to provide a superior yield to traditional fixed-income products.
In an uncertain world, surety has great value. And while selecting the right options for your portfolio depends on many variables, one thing seems certain: innovation is inevitable and marketplace lending is here to stay.
This article is intended for general educational purposes, not as an investment recommendation or individualized investment advice about any specific investor's portfolio.
About Brad Walker:
Brad Walker is Co-Founder and CEO at Income&, the innovator behind the PRIMO, a low-risk, high-yield, fixed-income product backed by hard assets. On Income&'s next-generation marketplace, investors can customize and purchase a diversified and fully transparent portfolio of PRIMOs.
Before founding Income&, Walker was Director of Institutional Products and Strategy for PENSCO Trust Company, America’s leading alternative asset custodian with over $10 billion in custodial assets. As Director, Walker developed PENSCO’s long-term institutional strategy and established himself as a thought leader on emerging financial technologies. Additionally, Walker managed the design and implementation of PENSCO’s new products and services, many of which have become industry standard.
Walker served in increasingly responsible positions in operations, purchasing, and strategy before his promotion to Director. Before joining PENSCO, Walker was a Research Associate at Fisher Investments, a prominent money management firm.
Walker graduated from Drake University with a BS in Business Administration. While an undergraduate, Walker began his career in finance at UBS Wealth Management.