Using the secondary market for above average returns on investment

With the majority of my p2p lending investments I hold the loans I invest in to maturity. Observing the market over the years I have observed patterns on the secondary markets that can be used to actively trade loan parts with the hope to increase achieved yields and I sometimes tried these.

I never specialized in this, so I never used fully automated bots, but did in some cases use some automation (Selenium or third party browser plug-ins). This article is not meant to be a how-to guide giving concrete instructions, that readers could just follow, but rather a list of things to consider and look for, should investors want to start testing strategies on the secondary markets themselves.

This article does not name or link any specific platforms, as I believe the same patterns and chances could evolve on new p2p lending marketplaces, and can be used there, you just need to look for them. Nevertheless all of the examples are real examples observed at the past by me.

Required market environment

The marketplace needs to have a secondary market that allows investors to buy and sell loans parts at premiums and discounts. Ideally without charging any transaction fees, but some strategies can absorb moderate fees. Furthermore it is advantageous if specific individual loans can be bought or sold rather than just random from the market or the investor’s portfolio.

The effect of premiums on yield

One central piece to understanding why trading (or flipping) strategies can be highly attractive is the effect of even small premiums pocketed on the portfolio yield. Take an investor that invests into a 100 (whatever currency) loan part and sells that part for 100.40 after holding it for 5 days. That is only a 0.4% premium, but the annualized yield is 33.8%. There is a big IF to that annualized yield number – it is only meaningful if the investor can seamlessly reinvest all his money in similar trades without any interruptions. So cash drag (effects of not invested cash) are very important.

The psychology

One would think that investors would always use rationale when investing into loans. However, I feel that a significant number of investors show one of these behaviors and the question an investor with a trading strategy should pose himself, is whether he can use that to his own advantage:

  • Scarcity
    If there is little left / available of a loan, investors fear of missing out
  • Unusual collector’s passion
    P2P Lending investors are told everywhere that diversification is vital (I tell them too). But especially on platforms with few loans, it seems that some investors strive to have a COMPLETE collection of loans in their portfolio and in pursuing that aim pay higher than average prices to acquire loans they ‘miss’ in their portfolio
  • Herd behavior
    Happens for example when investor (over)react scared by a news bit on a loan. In p2p lending that mostly effects the selling side rather than buying
  • Investors overvalue the realization of small gains
    Many investors are very happy to sell at small premiums –it just gives them a sense a positive achievement, not realizing that the market conditions for this specific loan part would have allowed selling at a higher premium
  • Blended by high numbers
    High nominal interest rates, and high YTM (yield to maturity) figures displayed by the platform overly attract investors

Two main strategy approaches

Investors can
A) Invest on the primary market and then sell the loan later on the secondary market
or
B) Buy loan parts on the secondary market which they deem underpriced and then sell at a higher price. Be it buying at discount and selling at a lower discount, or already buying at premium and selling at an even higher premium.

While yields achievable in strategy B might be higher in percentage, this strategy is much harder to execute, as the competition will most likely use automated bots. Also the total market size for attractive loans will limit the scalability. I never tried strategy B on a larger scale myself. For example I was never found of buying already defaulted loans at a huge discount. Nevertheless I know of some investors that fare quite well buying defaulted loans and selling them at a lower discount, pocketing any payments and recovery that occur while they hold them as an additional bonus.

Following I will concentrate on strategy A) Invest on the primary market and then sell the loan later on the secondary market – as I have used this myself on several platforms over time.

One important point, is that market conditions change, usually good opportunities will stop working after a few months or weeks either because too many investors try to use them, or more general  the demand/supply ratio changes or the marketplace itself changes the rules how the market functions.

  1. First an investor will want to look how loan information is presented on the primary and secondary market. Especially what sorting and filtering mechanisms there are on the secondary market. It is highly desirable that the loans the investor wants to sell later, will be listed on top of the list of all loans on the secondary market with either the defaulted sorting, or with an obvious choice of filtering (e.g. sort by descending YTM)
  2. Understand the allocation mechanism on the primary market. How does the autoinvest feature work exactly? If there is no autoinvest, then are there chances to heighten the probability of investing in attractive new loans? Either through automation, or just because new loans are released at specific times?
  3. When is interest paid? Does it accrue for each of the day held, or does the investor holding the loan at the date of the interest payment gets full interest credited. This is important, because if in the example at the start of the article the investor not only makes a 0.40 capital gain but also collects interest for the 5 days he held the part, it will have a huge impact on yield
  4. Usually for this strategy longer duration loans are more attractive. This is simply because they will allow higher premiums without making the YTM value unattractive for the potential buyer
  5. Usually smaller loans are more attractive. As there will be less supply it will be more liquid on the secondary market and more sought (see collector’s passion). No rule without exception. On one platform the biggest loans were the most attractive to be invested in on the primary market for the trading strategy. Why? Because this platform used dutch autions to set the interest rate and the bigger the loan the less the interest rate would go down. And of course loans with higher interest rates could later be sold at higher premiums
  6. Usually the time span a trading investor wants to hold on to a loan part, will be as short as possible (days). However there might be patterns observed where it could be desirable to hold for longer time spans. For example if on a marketplace there are repeated alternations between lots of new loans and time without any new loan, it might make sense to hold the loan parts till there are no loans available on the primary market and only then offer them on the secondary market
  7. Strategies that allow to hold parts only at a time when the status of a loan cannot change can be attractive. For example there was a time when it was possible to invest into very high interest, extremely high risk loans on the primary market of a specific platform and sell them at a premium BEFORE the first loan payment was due. Most parts sold within days, and the ones that did not sell at a premium, could be sold at par shortly before the date of the first loan repayment (this strategy worked due to a combination of factors: sorting by YTM, blended by high numbers (see above), and platform design – instant selling of loans offered at PAR).

So why is all this possible. Mostly due to market inefficiencies and lack of transparency and experience. The marketplaces are young, selecting and evaluating loan parts on the secondary market is not an easy task. And on many marketplaces investor demand outstrips loan supply . Usually the yields achievable with trading strategies go down as marketplaces grow (but the volume that can be used in these strategies might grow over time).

The most prominent question is, if an investor can scale strategies he uses to a level that is worth the time invested and the inherent risks.

My Lendit Europe Recap 2017

Lendit Europe time of the year again. My fourth time as a particpant of the London conference. It is now marketed as an ‘Event for Innovation in Financial Services’ and that means a wider scope of topics – and presenting companies – than in earlier years, when it had a single focus on p2p lending / marketplace lending. I truly enjoyed the conference, it had quality sessions and its high level attendants (more than 1100) allow great networking and making interesting contacts.

In writing this recap I find it much harder than in previous years to identify the main trends/topic that were discussed. There has been no single big announcement or issue happening that dominated the talks. So I’ll start with 3 predictions Renaud Laplanche, CEO Upgrade made in his motivating outlook on Online Lending 2.0:

  • Prediction 1: ‘The growth of online lending will accelerate in the next 15 months’
  • Prediction 2: ‘An organized secondary market for online loans will emerge in the next 15 months’
  • Prediction 3: ‘Continued re-bundling will give birth to at least one major consumer product innovation in the next 15 months’

From my viewpoint the first prediction is the one with the highest probability to come true, the second one is mainly important for the US market and it is actually the third one that is most interesting (but also most open).

Laplanche on Rebundling
His slide on rebundling examples

There are connections to another development that goes into the same direction and surfaced in several other sessions: More and more fintechs in this space are cooperating to better serve the customer and integrate multiple products into one user experience.

Furthermore there were several sessions around machine learning, artifical intelligence and automated underwriting with a wide range of opinions to what extend processes will be fully automated or whether human intervention or oversight is stll desireable for some specific decisions.

Looking at the scene from a geograhical perspective, many panelists emphasized that there are still a lot of difference between regions. The Americas, Asia or Europe (or even areas inside Europe) show a lot of differences no matter if the specific panel discussed funding, risk, investor yield, regulation or banking. So while many (especially VCs) would love to see fintech innovations that work globally and (if they are consumer faced) reach billions – that is extremly hard to achieve and therefore probably not going to happen in the near future.

This touches several speakers commenting and speculating whether the big tech giants like Amazon, Facebook, Google or Apple have ambitions and plans to offer financial services as they cater to a global audience, and what impact that would have on banks and fintechs. I found some aspects of this interesting, but mostly those discussions are futile because I feel there is such a lot of speculation involved and no real indicators that any of these companies are making steps in that direction. (sorry if there were any hard facts presented, I might have missed them as I did not see all the sessions).

I enjoyed Pitchit, where 8 startups battled for the vote of the jury and the audience. Swiss Sonect won both by hoping to replace ATMs by a platform approach where merchants can become the point where cash is dispensed (this is actually in collaboration with banks as they want to reduce the costs for maintaing ATM infrastructure and not anti-bank as it might sound on first impression).

All sessions at Lendit were recorded and will be made available over the next days here.

Seems like next year Lendit might come to a different location. The exit survey asked attendees to rate how they would like Frankfurt, Berlin, Barcelona vs London again.

 

Loanbook partners with Sage

Spanish p2p lending marketplace LoanBook announces a new partnership with Sage, provider of cloud accounting, payroll and payments software, to offer Sage’s Spanish customers a direct, in-product channel to alternative finance.

As part of the collaboration, Sage will offer its SME and accountancy customers access to LoanBook’s working capital loans, both in-product and within Sage’s wider ecosystem, stating Sage’s customers will benefit from a dedicated loan request portal enabling LoanBook to access customer data in order to improve the quality and speed of its loan underwriting.

Sage already has partnerships with other p2p lending marketplaces like Funding Circle and Marketinvoice.

James Buckland, CEO of LoanBook, commented: ‘We are excited to go a step further in our collaboration with Sage with a direct in-product integration. This partnership is based on the shared vision and commitment of Sage and LoanBook to support the SME community in Spain in becoming more competitive through improved access to finance and to innovative technology solutions.’

LoanBook has lent 21 million Euro to Spanish SMEs during the last 12 months and says it if providing a net annual return of over 5% for its investors.

International P2P Lending Volumes September 2017

This p2p lending statistic table contains the loan originations of p2p lending companies for last month. Funding Circle leads ahead of Zopa and Ratesetter. The total volume for the reported marketplaces adds up to 404 million Euro. I track the development of p2p lending volumes for many markets. Since I already have most of the data on file, I can publish statistics on the monthly loan originations for selected p2p lending services.

This month I added Raize, a marketplace in Portugal.

Investors living in national markets with no or limited selection of local p2p lending services can check this list of international investing on p2p lending services. Investors can also explore how to make use of current p2p lending cashback offers available. UK investors can compare IFISA rates.

Want to meet representatives of many of the listed companies? Attend Lendit London in October – use discount code WiseclerkVip to get a 15% rebate on registration.

P2P Lending Statistic 09/2017
Table: P2P Lending Volumes in September 2017. Source: own research

Note that volumes have been converted from local currency to Euro for the purpose of comparison. Some figures are estimates/approximations.
*Prosper and Lending Club no longer publish origination data for the most recent month.

Notice to p2p lending services not listed: Continue reading