Recently, I contacted a few well-known individuals in the field of P2P investing and sent them the following questions:
- What is a reasonable expected return on P2P investing?
- Where are the opportunities to add extra return (alpha)?
- What is the best way to invest? (Manually picking notes, using automated software, or via a fund?)
I was delighted to receive four very detailed responses. Two of the responses came from popular bloggers and enthusiasts on P2P investing. Both of them publicly share information about their portfolio and returns via their blogs. When they discuss their experiences, it is from the perspective of an actual investor. The other two responses came from industry innovators. Both have founded technology companies that automate the P2P investment process. Participants included:
- Nathan Marcos of BlueVestment (Innovator)
- Stu Lustman of P2P Lending Expert (Blogger)
- Emmanuel Morot of Lending Robot (Innovator)
- Ryan Lichtenwald of Peer & Social Lending (Blogger)
What is a reasonable expected return on a P2P Loan?
If investors focus on higher grade notes and stay diversified, I think a reasonable expectation is 8-9 percent. – Ryan Lichtenwald
The way many people calculate returns is kind of misleading. Especially as they do not annualize, so they boast ’16 percent.’ But then you realize it took them three years to reach that… Nowadays, anything slightly above 10 percent annual internal rate of return is good but shouldn’t be too hard to attain (with automation). – Emmanuel Morot
I think the long-term expectation of 8-10 percent is reasonable. Currently, I think we are in a favorable place as investors so I shoot for a minimum of 10 percent. I track my returns on my blog each month and have been over 1 percent per month return since I started my own investing so I’m pretty happy with that. – Stu Lustman
I feel reasonable expectations are from 10-13 percent annualized. There’s shift on either side but I feel that over time, these rates will lower. – Nathan Marcos
Where are the opportunities to add extra return (alpha)?
I have my own digital credit scorecard that I created and I consistently find that some B grade loans and most C and D grade loans are mispriced based on my own assessment of risk and use of my scorecard. – Stu Lustman
Well this gets tricky. I feel that there is too much reliance on proprietary labeling of loans (e.g. A, B, C, etc). These are labels that are slapped on loans by someone and the formulas are hidden. Formulas change over time, so drift occurs and that affects historical credit modeling. If someone is looking to create their own credit model or strategy, I strongly advise against using any proprietary data point outside the control of the user. – Nathan Marcos
I’m not aware of any specific grades that are mispriced and it would be hard to determine this as Lending Club’s underwriting can change over time. If investors want to have the chance for the highest returns, you need to be investing in higher-grade notes. I focus on C,D,E grade notes and currently have an average interest rate around 18 percent. There are a few common filters that people use to try and maximize returns. I personally use income, inquiries, FICO and employment length. For one of my Lending Club portfolios, I also utilize the statistical models from Bryce at P2P Picks. – According to Lending Club’s CEO Renaud Laplanche (Forbes article), there are no best notes. – Ryan Lichtenwald
How can one reduce risk without greatly impacting returns?
There are a number of investors who like to use P2P lending like a higher interest savings account and keep a conservative investment profile with almost all A or AA loans. Ten percent of their money into B and C loans or 10 percent in B and 10 percent in C would increase returns without any increase in risk. I’d also try to get more 36-month term loans than 60-month. – Stu Lustman
Diversification. Since there’s no per-loan-invested fees, put as little as possible in as many loans as possible. There are enough loans made available every day to still be able to be picky while doing this. – Emmanuel Morot
The secondary market has some great opportunities to earn solid returns by focusing on notes that have perfect payment history. The issue is that you have to continually check the market for notes. Besides the secondary market, investors can reduce their risk by using analytical tools to determine their filter criteria. This will allow you to see the filters that lead to lower default rates. I use Nickel Steamroller. – Ryan Lichtenwald
What is the best way to invest? (picking notes manually, using automated tools or via funds?
*None of this should be considered investment advice
I personally feel that as the P2P industry evolves, more investment vehicles similar to mutual funds or ETFs will arise and become within reach of retail investors, and that is the direction they should go. You will always have those individuals who wish to purchase themselves, but just as we’ve seen with the standard securities market, commissions and other fees will play a factor. I feel that automated investing tools like BlueVestment will become resources of institutions for making quick purchases according to their own strategies…actually powering the investment vehicle itself which other retail investors invest in. – Nathan Marcos
Automated tools are great for their convenience, but I do it manually myself and I think that everyone just getting started in P2P lending should do it manually at first. This is so they can see in a slower version in real time exactly how the process of filtering, selecting and buying a piece of a loan works. Funds are great, but since many have a limit of 99 partners, most of them cater to accredited investors. For those that have money and interest in the subject but no time, managed investments and funds are great. Funds are particularly good for someone with a lot of money to invest, as it can get pretty time-consuming buying little pieces of thousands of loans if they don’t participate in a whole loan purchase program. The other biggest benefit is that funds have access to multiple platforms like consumer lending, business lending, real estate or whatever other platform is out there in the marketplace, where little retail investors are much more severely restricted. They are very different than a bond mutual fund, since one of the measures of risk in a bond fund is the average duration. In P2P lending, 80 percent of the loans by dollar volume have been made in the last 12 months, and maybe as high as 90 percent in the last 18 months. Most of the loans are so new that average duration will be very similar across most P2P funds. The biggest risk in one of these funds is if their loan-buying guidelines differ greatly from yours, either by being too conservative or by seeking more yield for the risk than you would be comfortable taking with your money. As far as recommendations, as a non-accredited investor myself, I have not invested through any funds but I know of a few who have a good reputation in the marketplace, and those include PeerEx Investments and Direct Lending Investments. Peter Renton of LendAcademy is putting a fund together as well for investment. Prime Meridian is well regarded too. – Stu Lustman
I think this depends on the type of retail investor. For people like me, I like having a hands-on approach in my P2P lending investments and not paying someone else to manage my investments. Automating any significant amount of investment is necessary unless you want to be chained to your computer four times a day when notes are released by Lending Club. However, if someone simply likes the exposure to the P2P lending space, but doesn’t care to do research, then perhaps investing in a fund is a good route for them. Of course, this comes with an additional management fee and minimum investment requirements with most funds. There are great free analytical tools out there to be successful in P2P lending if one is willing to put in the time. If the retail investor is comfortable with the average returns, the time commitment is much lower. I am a huge proponent of automated investing. One downside to third-party automation is that you still have to provide your Lending Club credentials to them. It is not an ideal situation, but since Lending Club only allows your account to be connected with one bank account, in my opinion it isn’t a deal breaker. There is a lot of room for some of these tools to mature, and we have seen steps in right direction. For instance, LendingRobot is now registered with the SEC as a registered investment advisor. – Ryan Lichtenwald
“Disclosure: I am a Lending Club client and an editor of Learn Bonds on which Lending Club is an advertiser. This blog post contains several sponsored affiliate links and/or ads for Lending Club. If you click on a link or open an account through one of these links, I may receive a small commission from Lending Club. Additionally, I receive compensation from Lending Club for writing blog posts about Lending Club’s services.”
About Marc Prosser Marc Prosser is the Co-Founder of Learnbonds.com and an active investor in P2P Loans. He began researching the bond market after making an angel investment in iTB Securities, a broker-dealer that has been built an active trading bond platform for retail investors. Prior to becoming an entrepreneur, he was a pioneer in the forex trading space and the first employee and Chief Marketing Officer of FXCM between 2000-2010.