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Metal Masters

Finding High Yields in a Zero Interest Rate World: The Marketplace Lending Revolution

Dear HAA Reader, 

In this edition of Metal Masters, I want to share some information about how I’m investing part of my portfolio outside of precious metals. 

As you most likely know, I consider gold an essential component of every investor’s portfolio. And even more so in higher risk environments—such as the one we’re facing right now—where I am comfortable allocating 15% or more to precious metals. 

At the same time, while difficult, it’s essential for investors to hold a sufficient portion of total investable assets in cash. This prevents an investor from being forced to sell at an inopportune time such as the one we faced in 2008–2009. 

However, the main problem with having at least 10–20% of your portfolio in cash is you’ll be earning zero interest and losing money after taking inflation into account. This predicament, thanks in large part to Federal Reserve policies, has forced many would-be fixed income investors into other assets classes such as dividend paying stocks and REITS. 

Today, I’ll present you with another interesting option to improve the yield on the cash component of your portfolio. I personally have found this to be an effective solution to the low-rate environment we’ll likely continue encountering for quite some time. 

I wish you a successful and healthy 2017. 

Olivier Garret

Finding High Yields in a Zero Interest Rate World: The Marketplace Lending Revolution

With investors transfixed by the US financial sector’s plunge during the 2008 sub-prime lending crisis, a quiet revolution began that went largely unnoticed.

Given the scope and severity of the crisis, it’s understandable the SEC’s approval of the first peer-to-peer lending platforms attracted almost no attention.

While the origins of peer-to-peer lending date back to 2005, the 2008 SEC approval launched a new industry.

Since then P2P—or Marketplace Lending (MPL) as it is often referred to—has experienced exponential growth. By offering a combination of efficiency, convenience, high yields, and low volatility, the industry is increasingly cutting into the market share of traditional banks.

That’s because, as has been the case in many other industries, traditional banking is having a hard time keeping up with the fast-moving evolution brought on by new technologies.  The highly efficient and entirely online MPL platforms have fully automated the process of matching small borrowers with investors seeking higher yields than CDs or T-bills. That efficiency has slashed the time and cost involved with originating loans.

As a consequence, in the eight short years since SEC approval, the MPL industry has grown from a handful of startups to a $35B industry.

But the real growth remains ahead: Morgan Stanley expects MPL to experience a 47% compounded annual growth rate until 2020. And analysts at GrowthPraxis expect the online lending industry to reach $350 billion by 2025.

Despite the scandal at industry leader Lending Club—which led to the firing of its CEO—MPL is here to stay. In October of 2016, Goldman Sachs, the bluest of the blue chip financial institutions, entered the industry with the launch of its Marcus platform.

In a period of low returns on investments, today’s investors need to pay attention to MPL as one of the very few opportunities to earn attractive risk-adjusted yield.

How MPL Works

MPL lenders remove the middlemen and provide unsecured borrowers with competitive loans based on their credit score and other criteria found to be effective at rating risk.

The MPLs then offer the loans they originate in small tranches to investors seeking to diversify their risks across a broad swath of borrowers. That allows you, as a lender, to reduce the risk of any single loan default on your portfolio and to balance the yields you earn against your personal risk appetite.

Having followed this industry since 2009, I have been impressed by its robust business model. In its early years, investors needed to manage their portfolios manually and select each loan they wanted to invest in. While it is still possible to select individual loans, most platforms now allow you to automate the process. This makes it easy to deploy large investments over hundreds or even thousands of notes.

After reading a research report prepared earlier this year by my business partner, David Galland, and one of our senior research analysts at Garret/Galland Research, I decided to open an account with Lending Club (LC).

My experience with Lending Club has been overwhelmingly positive, making me wish I had opened an account years ago.

For starters, the account-opening process for an individual account is seamless and took less than 10 minutes. For an individual account, there is no minimum investment required.

I was so pleased with my experience opening an individual account, I subsequently opened a corporate account. While the process for a corporate account was a bit more cumbersome—and it requires a $50,000 minimum—it was no more difficult than opening a bank or brokerage account.

Upon transferring funds into my account, I setup the investment criteria for my portfolio. The LC platforms separate borrowers into 7 different risk categories, each based on the borrower’s average credit score and history. The platform also provides historical default rates by category and calculates an anticipated risk-adjusted return for each category.

You then decide which different categories of borrowers you wish to spread your investment across. For example, you might choose to split your investment evenly between the two safest categories, A & B. Or, if you are comfortable with taking on a bit more risk in exchange for a higher yield, you could split your investment evenly across all categories. Before making your final decision, Lending Club has tools you can use to compare several different scenarios and the returns they anticipate you will receive.

In the end, I chose to allocate about two-thirds of my investment into the three safest categories and one-third to the four riskiest. Next up, I had to decide the maximum size of the loans I would make to any individual borrower. Although I was investing over $50,000, I decided to significantly diversify my risk by making loans of only $100 per note. I then let the platform’s automated investment process start.

The Results… So Far

Over the next couple of weeks, my entire investment was deployed across hundreds of notes—all of which perfectly matched the risk profile I had requested.

Lending Club offers online access, allowing me to easily review my portfolio and the returns I have earned. For convenience sake, I have chosen to automatically re-invest the monthly interest and principal I earn, but can change this selection at any time and receive the proceeds regularly.

Based on the risk profile I selected, my anticipated risk-adjusted return is more than 6% per annum—a better and safer return than I could earn with most comparable 3- to 5-year high yield funds.

Are there risks associated with P2P lending? Absolutely:

  • P2P accounts are not FDIC insured; the notes are securities.
  • The loans are not secured; default rates will increase if we enter a recession, though higher default rates are more likely with sub-prime borrowers than with people with the highest credit scores. Something to keep in mind when selecting the risk level for your portfolio.
  • There could be some risks associated with the business failure of the MPL company. Its financial health needs to be monitored. Lending Club currently has an equity-to-book ratio of nearly 20%, which is significantly better than the capital ratio of almost any bank.

For the average investor looking for higher yields, the risks of MPL are entirely manageable. And the returns you earn are almost completely unaffected by typical stock or bond market volatility. That allows you to sleep well—an added bonus in uncertain times.

I have only touched on the basics in this article.  Before you get started though, I recommend you read David’s Marketplace Lending Report. This free report does a comprehensive comparison of the different MPL platforms and contains important insights on how to earn the highest returns, with the least amount of risk—click here to download your FREE copy.

Olivier Garret, CEO
Hard Assets Alliance


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