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With new mutual funds, marketplace lenders continue to seek diversified sources of capital

Marketplace lending is getting somewhat of a bad rap recently. Just last week, the Consumer Financial Protection Bureau slapped LendUp, with a $1.8 million civil penalty and ordered the company to provide more than 50,000 consumers with approximately $1.83 million in refunds. Earlier this year, the Lending Club scandal, which caught the CEO creating undisclosed sources of capital, sent pundits into a frenzy about the fate of marketplace lending.

The scandal was indicative of the capital crunch happening to marketplace lenders. As hedge fund pools dried up, new sources of capital are emerging. The first two marketplace lending mutual funds, sponsored by Stone Ridge Asset Management and RiverNorth Capital Management, were approved recently in the U.S. by the S.E.C., with similar funds launched earlier in the U.K.

“This is an exciting opportunity for RiverNorth and our investors,” said Philip Bartow, co-portfolio manager of the RiverNorth fund. “The benefit of being early to the retail market will give us the enhanced ability to purchase loans directly from quality online lending partners with whom RiverNorth has negotiated loan acquisition and servicing relationships.”

More funds have filed to become ’40 Act funds for marketplace lending and are awaiting S.E.C. approval.

The marketplace lending funds were designed as interval funds, which means that investors can invest money into the fund at any time. Redemptions, however, are restricted to certain time periods and certain amounts. Both U.S. funds only allow redemption on a quarterly basis.

Though anyone can invest directly on the marketplace lending platforms, they are cumbersome compared to mutual funds, a product investors and advisors know how to manage. In order to invest in marketplace lending, one needs to open a new account and learn a new set of analytical tools to aggregate and select loans that fit his risk preferences. If an investor wants to invest in more than one platform, this problem might become prohibitive.

Alternatively, hedge funds, which comprise a big chunk of the capital in marketplace lending, are only open to accredited investors. Launching these mutual funds will give retail investors easier access to consumer debt.

“By expanding marketplace loans to a broader investor base, these new funds will transform the industry and could eventually move today’s platforms towards principal broker-dealer markets, similar to other fixed income instruments,” Monja, a marketplace lending analytics solution, explained in a blog post.

To access other sources of capital, marketplace lenders have also begun securitizing their loans.

According to PeerIQ, Q2 2016 marketplace lending securitization volume topped $1.7 billion, up 14.8 percent from Q1. Also that quarter, SoFi issued its first rated unsecured consumer loan deal and received an industry first ever AAA rating from Moody’s on its recent student loan transaction.

The growth in Q2  brings the total size of marketplace lending securitization issuance volume to date to $10.3 billion.

mpl-securitization

The upswing in marketplace lending securitization comes against a backdrop of an uptick in collateralized loan obligations of all sorts. According to the Financial Times, banks project $50-$60 billion in CLOs sold by end of year in a ‘frenzy of issuance’.

Citi, Morgan Stanley, and Credit Suisse are leading in marketplace lending securitization deals. The top five bookrunners captured 75 percent market share, or 34 of 41 deals. Earlier this year, Citi  suspended an agreement to securitize Proper’s loans, but that did not affect general trends.

As these products establish a track record for performance, demand for them is expected to grow as well.

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Ivy Tower Investing Report Week of July 1, 2012

Top investing research for the week of July 1, 2012

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Retail Brokerage Manifesto

I’ve been in the investment business for 10 years now wearing a variety of hats.  I’ve been a hedge fund analyst (small cap/tech/retail/food), ran business development for Seeking Alpha, and hold both a brokerage rep license (Series 7) and an investment advisory license (Series 65).

For the nuanced, a broker makes a living transacting stuff and an advisor is prohibited from doing this.  Even though the vast majority of my business is done as a fee on assets (not based on commissions), it’s sometimes strange wearing both hats.  I approach the business as an investment advisor would but typically manage accounts under my brokerage license — this allows me to develop unique portfolios for individual clients.  It’s inherently less scalable than an one-size-fits-all portfolio but it’s also good service and good business.

As I reflect on the past and plan for the future, I’d like to share the tenets of how I personally approach the business of investments.  It’s the creed I live by and it’s what helped me continue to grow.  Some of this is required by law, regulatory statute or is just plain my opinion.

Tradestreaming Broker’s Manifesto

  1. I don’t believe it’s inherently wrong being paid to manage client assets, even if I get paid a commission
  2. That’s because I always have the client’s best interest in mind
  3. Even if it conflicts with my own personal financial incentives
  4. Even if I *lose money* on the trade (independent reps have transaction costs on trades that they need to cover)
  5. I always told myself that in spite of the power a broker has over client decision making, I would never hard sell anything
  6. Always look for ways for clients to save money
  7. That may mean comparing Mutual Fund A vs. Mutual Fund B but it also means comparing Mutual Fund A vs. ETF A (one pays a trailer, the other is a transaction)
  8. Nobody says anyone needs to be in the market or needs to have a 60/40 portfolio
  9. The extension of this is that the best client performance sometimes comes from designing a portfolio from the ground-up, not top down and not by cramming a client into a pre-ordained portfolio or allocation
  10. I don’t believe in the Efficient Market Hypothesis (EMH) and do believe that clients can do better than the markets without having to assume more risk
  11. That said, while the potential to beat the market exists, it may be elusive and in specific cases, may not be worth trying
  12. Sometimes an honest broker makes his money by keeping clients out of trouble and that’s worth something, too, even if clients don’t necessarily recognize this
  13. There are a lot of brokers making their clients a lot of money and really doing good by them.  I want to be part of this group.
  14. Everyone in financial services has conflicts of interests and how you get paid is just one of them.  Regardless of licensing structure, good financial advice requires being honest and open with yourself and clients.
  15. Clients don’t begrudge their advisors making money and some feel good giving the business even if they could transact using an online broker
  16. But they won’t forgive if it’s done at their expense
  17. That said, very few clients could rightfully decipher if this was the case so the whole thing rests upon the broker/advisor being honest and open with him/herself.
  18. There aren’t many of us who behave as we do and that’s OK.

Do you have anything to add? Let me know in the comments.

photo courtesy of battlecreekCVB

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Blowing up the fine print in financial product marketing

As a user of various financial products over the years, I sometimes wonder what it is I actually own (most of the time this occurs sometime after hitting some single malt before bed and sometime before day break).  I dunno — I read the labels on food that I ingest.  Just thought it might be interesting to know what’s in the mutual fund into which I invested all my life’s savings.  Just for kicks, you know?

So, I decided to do a little sleuth work and *pull back the covers* on the disclaimer language on some of the most widely held financial products.  What I found written in Arial font size 6 might be a little surprising to owners of mutual funds and ETFs:

Of course, past results are not at all, in any way, form, or fashion indicative of future performance.  No way and it doesn’t even matter that we have to say that.  We probably would anyway just to cover our own asses.  Anyway, in terms of performance, it’s really just a crapshoot.  Who wrote that Random Walk thingie again?  We’re not big fans of him (he’s probably an academic).  We don’t love Bogle either — he’s the one who tried to force us into buy and hold strategies.  Cramer’s more our speed, if you care.  We sell/market financial products that trade in a secondary market so we don’t really care all that much anyway how they perform.  As long as we grow our assets under management and provide liquidity to the products.  In fact, we’re not quite sure what to make of all the blogger research that shows that our ETFs don’t come close to tracking the indices they’re supposed to follow.  And those leveraged ones — the 2x, 3x, 4x, XXXs — who really understands how all those things work?  I mean, can you really use daily future rebalancing as part of a core strategy anyway??  Thankfully for us, it’s products like these that enable us to raise our management fees in an environment that continuously pushes fees down.  We had it good with mutual funds — whose stupid idea was to transition to lower-fee ETFs? By the way, if you really want performance, why not try just giving your money to one of those fancy hedge fund vehicles?  They seem to know what they’re doing, right?  Man, I’d like to be in their shoes.  Me?  I’d be David Tepper or maybe  Bill Ackman.  Yeah, Ackman.  With his build and that gray heirhair, he’s totally a baller investor. Also, you should know, that we don’t really believe all that new-fangled behavioral research that shows that for investors, our products are sort of like drugs in the hands of addicts.  In essence, there’s no way these people are going to make money in the market anyway.  So, why not provide a vehicle that purports to do as much.  Is that so bad?  Is it?

Wow, who knew what was written in all that small print?

photo courtesy of somegeekintn
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Read the fine print, investors: Some mutual fund fees higher than thought

We’ve written for a while that for certain purposes, Exchange Traded Funds (ETFs) are a better mousetrap.

As Mutual Funds 2.0, ETFs have introduced:mousetrap

  • new ways to implement investing ideas (eg. country exposure to Poland, Chile, etc.)
  • made existing ideas easier to trade (leveraged long and short funds, buy-write strategies)
  • provided continuous pricing (unlike Mutual Funds that price once at the end of the day)
  • more competitive management fee structure (ETFs are typically passive investment tied to an index)
  • eased the tax burden (some ETFs are able to pass on very little capital gains to the investor either through legal loopholes or just low turnover of the portfolio)

Mirroring as a new investment model

What’s true of ETFs is also true for new investment models, called mirroring.  Trade mirroring allows investors to synch their online brokers with a portfolio manager’s every move.  Unlike a traditional mutual fund manager who pools assets together, newer structures have portfolio managers managing a theoretical model (3% in X, 5.5% in Y, etc.).  This model is executed in client accounts (which are typically held elsewhere).  When a portfolio manager makes a change in the portfolio, it is then mirrored in the client account.  See this example of a mirrored account that tracks Warren Buffett’s moves.

Pricing is typically competitive to similar mutual fund strategies and investors pay a management fee + some fee whenever a trade is executed in their accounts.  Because assets are held in the investor’s own account and not comingled (like in mutual funds), the investor never has to share in gains or losses of the fund as a whole — in fact, the investor has some leeway to practice tax loss selling as well to pair losses vs. gains.  In this sense, mirrored accounts are much more tax efficient when compared to mutual funds.

Brokers have sold these types of accounts for years, called Separately Managed Accounts (SMAs), where investors could get access to some of the world’s best asset managers with just a fraction of the assets typically required to access these managers.  Now, we’re seeing the same models rolled out to do-it-yourself (DIY) investors.

It’s these last 2 benefits of newer investment vehicles – lower management fees and softer tax burden — that’s become an interesting bone of contention in the ongoing tug-of-war between the mutual fund industry and new emerging types of asset managers (including, but not only, ETFs).

Disagreement over *real* pricing

kaChing, an expert investing community which allows investors to invest alongside rising-star portfolio managers, recently introduced its own analysis (along with help from Lipper), that shows the average fees charged by mutual funds are much higher than investors typically realize — averaging over 3%.

In an article last week on the Wall Street Journal entitled “Mutual Fund Fee Debate Heats Up” (sub required), Ian Salisbury compares kaChing’s findings to those of the mouthpiece of the mutual fund industry, the Investment Company Institute (ICI).  As the WSJ reports that the ICI’s tally of the average fees charged on mutual funds hovered just over 1%.

So which is it — >3% or >1?  Clearly the answer is very important for investors.  Why? Because investing is a simple formula:

Net investment returns = Gross investment returns – taxes – fees

Given that higher taxes eat away at any return we get, lowering taxes is extremely important.  If kaChing’s numbers are correct, there’s no way the average mutual fund can even come close to beating the markets.

Couple of caveats to think about here:

  • We’re dealing with averages here:  If the average mutual fund (with 60% turnover per year, as per the ICI’s 2008 Factbook) passes through such a high tax burden to its investors loses versus index funds, that’s not to say that certain funds do charge less and return more.  Let’s not throw the entire mutual fund baby out with the fee bathwater.
  • kaChing’s execution costs for high turnover portfolios: kaChing will be producing a side-by-side analysis of their typical costs vs. those of the average mutual fund in the upcoming moths.  While kaChing (and competitor, Covestor) may indeed have lower management fees and be a lot more tax sensitive for investors, their execution costs (typically $.02/share) will eat up gains.  High volume turnover will still eat into profits.  Investors will continue to pay for professional portfolio management.
  • Transparency typically benefits the investor: It’s hard to tell exactly what mutual funds charge their investors.  Consequently, firms like kaChing are competing head-on with mutual funds and appealing to average investors by attacking the industry’s Achilles Heel: transparency.  They are banking that, as social media’s Facebook and Twitter phenomena have created new levels of visibility, so too investors will demand it in the financial industry.
  • Fees are important but not the only factor: Too many times investors will forgo professional management because they feel the fees are too high.  While that may be relatively true, there are other factors on which an appropriate investment must be sized up (risk-weighted returns is a huge one for individual investors to better understand).  Everyone on all sides of the aisle is trying to sell you something — caveat emptor.  There are no free lunches.

Anyway, check out the kaChing analysis, read what the WSJ had to say, and I’d be interested to hear your feedback.

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stock screen, screening 2.0, investing, warren buffett, peter lynch, dreman

As if we needed another study to spell this out, S&P published a recent study (.pdf) that undermines the hot money chasing performance in the mutual fund industry.  The study shows that very few funds demonstrate persistence — the ability of asset managers to consistently achieve top-quartile or top-half performance.

The amazing take-away from the study:

Over the five years ending September 2009, only 4.27%
large-cap funds, 3.98% mid-cap funds, and 9.13% small-cap funds maintained a top-half ranking over the five consecutive 12-month periods. No large- or mid-cap funds, and only one small-cap fund maintained a top quartile ranking over the same period.

Couple of things here:

  • Not one large-cap or mid cap fund maintained top quartile ranking.  Should investors just use large cap and mid cap indices for their exposure here regardless?
  • While still posting rather poor results, there are twice the percentage of small cap funds achieving top-half performance than large caps.  There still seems to be significantly more value in active portfolio management in the small cap arena.

The study’s ultimate takeaway:

Our research suggests that screening for top-quartile funds may be inappropriate.A healthy plurality of future top-quartile funds comes from the prior period’s second, third and even fourth quartiles. Screening out bottom quartile funds may be appropriate, however, since they have a very high probability of being merged or liquidated.

Compare that to the findings of Jagannathan, Malakhov, and Novikov in “Do Hot Hands Exist Among Hedge Fund Managers?”:

We find evidence of persistence in the performance of funds relative to their style benchmarks. It appears that on average more than 25% of the abnormal performance during a three year interval will spill over into the following three year interval.

[Hat tip: Pragmatic Capitalist]