The Evolution of Marketplace Lending

The Evolution of Marketplace Lending

One of the interviewees in my new book ValueWeb is Ron Suber, President of Prosper Marketplace Lending. Ron gave a speech last week which is summarized below. Well worth a read.

It’s clear that just like payments, movies and music have moved online, the global move to online borrowing and lending is well underway. It’s unanimous. But, it’s not for the faint of heart!
 

While we have many evangelists and fans, there are also many skeptics, as well as myths and misperceptions about our industry that have been increasing with every misinformed story that is published.

The industry is also working feverishly to educate policymakers and inform sound policy development through new organizations, such as the first Marketplace Lending Association.

Now the industry is at an inflection point. As I noted this year (and last year), our industry has evolved from a novelty, to an interesting new niche, to a great idea.

In order to become something that people can’t live without (i.e. the smartphone), there are changes and improvements that our industry needs to make. These include:

  • Improving Risk and Underwriting: We must continue to improve our risk models, verifications, and collections practices. This is the most important thing we do and it will continue to be the most important thing we do as our industry matures.
  • Maintaining an Equilibrium in the Marketplace: More balance between what I refer to as the left (investors) and right (borrowers) legs of the stool (the marketplace). There are periods of imbalance for any marketplace business – we’ve seen this with Uber and AirBnB as they gain scale and mass adoption. Still, equilibrium is something we all continually strive for and it will continue to be a major focus and priority for all marketplace lending platforms.
  • Developing New Products: We have witnessed a shift in the way people interact with marketplaces on a day-to-day basis, thanks to companies like Amazon and Ebay. If we strive to better understand our customer’s daily needs, we can shift the way people interact with their personal finances on a day-to-day basis. To do this, we need to continue to deliver new products and services that make it easier for investors to invest in our loans. Until we increase access to our asset class through new vehicles, we will not be something that people can’t live without.
  • Establishing an Open Ecosystem: Open systems thrive, while closed systems become obsolete. From AOL to Blackberry RIM, to the biosphere, we’ve seen time and again that closed systems do not scale. Marketplace lending needs to be ubiquitous. To do this, we must maintain an open dialogue, educate and share information with the public and create a broader understanding of our platforms and products. We need to encourage the development of a sophisticated ecosystem for our industry that improves data visualization, transparency, standardization and liquidity. Firms like Orchard, PeerIQ, DVO1 and Monja are already helping to pioneer this ecosystem.
     

As we look towards the future, I encourage the collective marketplace lending industry to embrace the notion that change is inevitable. This type of change requires a certain amount of resilience but it is necessary. As we go through this evolution together, I urge the industry not to lose sight of our important shared goal: to give people access to affordable credit.

Just for further information, here’s an overview of Prosper:
 

Q4 proved to be a record breaking quarter for Prosper, with $1.15bn in loans originated through the platform. The $1.15bn closes out a year in which a grand total of $3.7bn was lent. That’s more than double what the platform accomplished in 2014, when $1.6bn was lent on the year. Prosper’s cumulative lending volume now sits somewhere between the $6bn and $7bn mark. SoFi hit the $6bn mark about a week before Christmas. The race for second place in the marketplace lending volume game is heating up.

We also learn that Prosper hired a massive 105 people in the 4th quarter of 2015 alone. For some perspective, there are perhaps only 3 platforms in the UK – perhaps less – that employ over 100 staff. Prosper is now home to 623 employees, up from 238 at the close of 2014.

Chris Skinner
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Chris Skinner is one of the most influential and prolific thought leaders on the future of banking, finance and technology. The Financial Brand awarded him best blog and ... Click for full bio

Alternative Beta Strategies: Alpha/Beta Separation Comes to Hedge Funds

Alternative Beta Strategies: Alpha/Beta Separation Comes to Hedge Funds

Written by: Yazann Romahi, Chief Investment Officer of Quantitative Beta Strategies, J.P. Morgan Asset Management

A quiet revolution is taking place in the alternatives world. The idea of alpha/beta separation has finally made its way from traditional to alternative investing. This development brings with it a more transparent, liquid and cost-effective approach to accessing the “alternative beta” component of hedge fund return and a new means for benchmarking hedge fund managers.

The good news for investors is that the separation of hedge fund return into its components—rules-based alternative beta and active manager alpha—has the potential to shift investing as we know it. These advancements could democratize hedge funds and, at long last, make what are essentially hedge fund strategies available to all investors—even those who aren’t willing to hand over the hefty fees often associated with hedge fund investing.

A benchmark for alternatives


With respect to traditional equity investing, we have long accepted the idea that there is a market return, or beta—but this hasn’t always been the case. Investors used to assume that to make money in the stock markets, one needed to buy the right stocks and avoid the wrong ones. The idea of a market return independent of skilled stock selection seemed ridiculous to most market participants. Yet today, we would never invest in an active manager’s strategy without benchmarking it against its respective beta.

Interestingly, hedge fund managers have been held to a different standard. Investors have been much more willing to accept the notion that hedge fund strategy returns are pure alpha, and that their investment returns are based entirely on the skill of the fund manager. That notion explains why investors have been willing to accept a “two and twenty” fee structure just to access what has been perceived as one of the most sophisticated and powerful investment vehicles available.

In thinking about the concept of beta, consider its precise definition—the return achievable by taking on a systematic exposure to an economically compensated risk. In traditional long only equity investing, the traditional market beta has been further refined as a number of other risks have been identified that are commonly referred to as “strategic beta.” These include factors such as value, momentum, quality and size. But no one ever said that these risk factors must be long-only.

Over the past decade, as more hedge fund data became available, academics began to disaggregate hedge fund return into two components: compensation for a systematic exposure to a long/short type of risk (alternative beta), and an unexplained “manager alpha.” What they found is that a significant portion of hedge fund return can be attributed to alternative beta. That fact has turned the tables on how we look at hedge fund return. With the introduction of the alternative beta concept, hedge fund managers will have to state their results, not just in terms of total return, but also as excess return over an alternative beta benchmark.

Merger arbitrage—an alternative beta example


The merger arbitrage hedge fund style can be used to illustrate the alternative beta concept. In the case of merger arbitrage, the beta strategy would be the systematic process of going long every target company, while shorting its acquirer. There is an inherent return to this strategy because the target stock price typically does not immediately rise to the offer price upon the deal’s announcement. This creates an opportunity to purchase the stock at a discount prior to the deal’s completion. The premium that remains is compensation to the investor for bearing the risk that the deal may fail.

Active merger arbitrage managers can add value by choosing to invest in some deals while avoiding others. Therefore, their benchmark should be the “enter every deal” strategy, not cash. In fact, the beta strategy explains the majority of the return to the average merger arbitrage hedge fund. And it doesn’t stop there. Other hedge fund styles that can be explained using alternative beta include equity long/short, global macro, and event driven. Note that the beta strategy invests in the same securities, using the same long/short techniques as the hedge fund strategy. The difference is that the beta strategy is a rules-based version that can become the benchmark for the hedge fund strategy. After all, if a hedge fund strategy cannot beat its respective rules-based benchmark (net of fees), an investor may be wiser to stick to the beta strategy.

Implications for investors


What does all this mean for the end investor? Hedge funds have traditionally been the domain of sophisticated investors willing to pay high fees and sacrifice liquidity. Alpha/beta separation in the hedge fund world means that investors can finally choose whether to buy the active version of the hedge fund strategy or opt for the passive (beta) version. Hedge fund strategies can be effective portfolio diversifiers. Now, through alternative beta, virtually all investors can access what are essentially hedge fund strategies in a low cost, liquid, and fully transparent form. For investors who haven’t had prior access to hedge funds, this could be welcome news. Not only can investors look at an active hedge fund manager’s strategy and determine how it has done compared to the systematic beta equivalent, they can also invest in ETFs that encapsulate these systematic strategies.

When looking at one’s traditional balanced portfolio today, there are plenty of questions around whether the fixed income portion will achieve the same level of diversification it has provided in the past. After all, with yields still low, there is little income return. Additionally, the capital gains that came from interest rate declines are likely to reverse. With fixed income unlikely to adequately fulfill its traditional role in portfolios, there is a need to find an alternative source of diversification. This is where alternative strategies may help. For investors seeking to access diversifying strategies in liquid and low-cost vehicles, alternative beta strategies in ETF form are one option.

Looking for an alternative to enhance diversification in your portfolio?


For investors looking to further diversify their overall portfolio, JPMorgan Diversified Alternatives ETF (JPHF) seeks to increase diversification and reduce overall portfolio volatility through direct, diversified exposure to hedge fund strategies using a bottom-up, rules-based approach.

Learn more about JPHF and J.P. Morgan’s suite of ETFs here

DISCLOSURE

Call 1-844-4JPM-ETF or visit www.jpmorganetfs.com to obtain a prospectus. Carefully consider the investment objectives and risks as well as charges and expenses of the ETF before investing. The summary and full prospectuses contain this and other information about the ETF. Read them carefully before investing.
J.P. Morgan Asset Management
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