For more than a year I’ve invested in “crowdlending”, and it has boosted my income by $1100 per year.
Many of you have asked about my investments in this asset class. You especially wanted to know how I determine the risk.
We’ll also discuss how (if) it could fit with a dividend growth investment related strategy.
Note that while I know work in one of these firms now, I did all my investments in this sector before I started.
Moreover, I don’t have any ownership in the firm, and I’m restricted to investing more in this asset class. This article is therefore only to be seen as an answer to a question of why I invested in crowdlending in the first place.
Also, I never “recommend” or talk about anything that I, myself, haven’t invested or considered investing in. Stockles is a neutral blog and always will be.
What has changed during the recent years is that the fixed income class “corporate bonds” has been made acceptable for private investors, and not just institutional investors.
This accessibility means that investors like you and I finally invest in quality loans providing a higher yield than the dull “normal” bonds, just like the banking industry does.
And this is the interesting part – corporate bonds can give investors yields ranging from 10% to 20% and yet provide far less risk than stocks providing the same yield.
Few opportunities to find safe high yielding assets
If you want to achieve yields as high as 10% or even more, there are just a few investment opportunities available and most of them provide significant risk.
– Energy stocks: Shipping or oil-related firms generating very high yield one year, only to cut the dividend the next as a consequence of fluctuation free cash flow. I’ve done this mistake before and I’m not planning to do it again…
– MLPs: Second is Master Limited Partnerships (MLPs), but they also provide extreme risk and often operate with very volatile earnings history. Wall Street is very bearish on MLPs right now and gives a very negative earnings outlook for the whole sector. I’d stay away if I were you!
– REITs: Lastly, the Real Estate Investment Trust (REIT) sector might at times provide such high yields, but most rates providing very high yields belong to the volatile and decreasing retail sector. There’s even specific funds target this “retail Armageddon” such as ProShares Long Online/Short Stores ETF (Ticker: CLIX)
Yet, investors are forced to buy high-yielding stocks…
What keeps pushing the market higher and higher is that investors feel forced to buy high yielding equities as a response to the very low-interest-rate environment.
Just take a look at the picture below. Interest rates are low, which explains why high yield & low growth stocks such as Southern Company (Ticker SO) have moved more than 40% in a single year.
While any speculation of how long this can continue is meaningless, I observe that very low growth stocks such as utilities have soured lately primarily due to this single reason. And that’s why I wanted to diversify my portfolio into a new asset class called crowdlending.
A quick explanation of how crowdlending works
1. Small and midsize firms (SMB in Norwegian) apply for loans, just like they would do in any other bank.
2. The crowdfunding team performs a credit risk assessment and establishes a risk score, ranging from A, B, C, D and E where A is considered the safest investments. Class A loans often offer yields in the range from 6% to 8% and can be considered safe.
3. The loan is then published on the platform, and investors from all over Norway investments money into the loan and receive interest on their investment.
Now, you might ask:
Why can’t these firms just go to a normal bank and pay less interest fees?…
Why do they accept such high-interest rates?…
Well, it’s complex…
Part of the reason is that large banks normally have restrictions on have much they can invest in various sectors such as oil or gas.
Therefore, even though the projects are profitable (as NPV > 0), they have to decline the customer due to risk-aversion within their selected portfolio.
Another reason is that banks often require far more business history than what small and midsize companies can provide, and therefore, they are neglected from the bank’s loan portfolio.
Will this sector grow in the future?
The crowdlending segment is expected to show a transactional value growth of 21.2% in 2020, and the total transactional value is expected to go up from $180,780 million in 2019 to 290,135,5 million in 2023.
China ranks on top but interestingly enough UK had a transactional volume of $2,441 million.
Our neighbors? Finland had $148,9 million and Norway only $44.3 million. Finland’s crowdlending market is thus almost 4 times as large as ours.
I find that a bit strange given the similarities between our countries, and one might expect Norway to more on par with Finland. If so, the Norwegian crowdlending market should experience rapid growth from now on.
The downside of investing in crowdlending
As with any investment I do, I care more about the downside than the upside – which is something I have in common with both Warren Buffet and George Soros (in general, that’s a good way of approaching any investment).
Also, I never “recommend” or talk about anything that I, myself, haven’t invested or considered investing in. Stockles is a neutral blog and always will be. As such, let’s look at the pros and cons.
The major disadvantage with crowdlending as I see it is that the historical data is bad.
The best articles I’ve found on the subject are how might peer-to-peer investing do during a recession and Is P2P lending safe? The first article studies the performance of Lending Club which had operations already during the financial crisis.
As such, it might be used as an indicator for future returns during crashes and recessions.
The chart below represents the loan performance of Lending Club from the first quarter of 2007 through the fourth quarter of 2009. That’s three years roughly encompassing the Financial Meltdown.
Highlights from the article include
– Note that during this time frame, the lowest grade loans — FG — had a net annual return of just 0.64%. The average interest rate was 17.65%. That means loan losses were about 17% of the portfolio! Translation: Nearly 100% of interest income was eaten up by loan defaults.
-But in looking at the top of the chart, the highest-quality loans, those with an A rating, had the highest net annualized return, at 5.26%. The average interest rate for the group was 8.68%, reflecting loan losses of just 3.42%. This was the lowest default rate of all credit grades.
The moral of the story is yield is not all that matters with P2P lending, especially during economic downturns. A recession — or the prospect of one — should have you favoring higher grade loans
While this data isn’t as good as we want it to be (more data is always better), it suggests what we can expect: Higher grade ratings should perform pretty good, while low-grade ratings are worse, which also tells me that it’s crucial to diversify when investing in this asset class. The author of the research concludes with:
Until the industry successfully weather’s a recession, it might be better to consider P2P investments as something like high-dividend stocks — they’re safer than growth stocks, but they’re not safe in the strictest sense of the word (source)
My takeaway from this is to stick with the highest rates loans as they most likely provide a great income with far lower risk than the riskier classified bonds.
In which way can crowdlending work then?
I love stocks and will by all times have most of my investments in high-quality stocks paying growing and consistent dividends. But I’ve found it more worthwhile to replace risky high dividend-paying stocks with crowdlending. I do believe this asset class will perform substantially better than most high-yield stocks over the next decades.
If we look at statistics provided by Funding Circle, very few investors experience net returns below 3-4%.
This leads me to believe that the chance of actually losing a lot of money on this asset class is relatively small, at least as long as I mainly invest in loans with a high credit rating and diversify my investments.
The return figures are based on 21,086 investors who have lent For at least one year, and that has diversified their portfolio as indicated in the graph for at least 75% of the time they have invested through Funding Circle. This is equivalent to 44.3% of all active investors in the platform.
What have I invested in?
In total, I’ve invested around 130 000 NOK in 7 loans at FundingPartner with yields ranging from 6.90% to 12.00%. In terms of volume weighed investments, most are in the A and B rated loans.
In hindsight, I would have diversified even more. As this asset class becomes more and more popular, I think the available investments will increase too.
As you can see, I earn about $90 or 757 Kr per month from my investments in the sector. My net return is 9.2% (10.2% – 1% fee), which I consider to be good when comparing to a high- yield stock at 9.2%.
Summed up: Stocks and crowdlending can be combined, but go for quality
Back in 1930, Benjamin Graham recommended holding 80% bonds and 20% stocks when the market seamed overvalued.
My recommendation is to almost always go with at least 80% stocks. Most young people have time on their side and can thus take the risk of volatility in the market.
Because remember this, risk is often misunderstood.
Most of the time, especially if you buy an index fund and hold for a long time, risk isn’t the chance of losing money, but the risk of seeing your investment fluctuates.
That’s a risk and that’s why you get paid more to own equities than bonds.
Moreover, most investors hold growth stocks and seek either dividend stocks, gold or bonds as alternatives to play both sides.
I, therefore, see crowdlending as an alternative asset class to these investments and believe that this sector will grow substantially as people become more comfortable with the asset class.
Disclaimer: The information contained on this Website and the resources available for download through this website is not intended as, and shall not be understood or construed as, financial advice. I am not an attorney, accountant or financial advisor, nor am I holding myself out to be, and the information contained on this Website is not a substitute for financial advice from a professional who is aware of the facts and circumstances of your situation.