LendingClub's Valerie Kay weighs in on the rapidly shifting landscape of alternative lending from an investor perspective.
When the first widely-known credit marketplaces, then called peer-to peer (P2P) lenders, arrived on the scene in 2007, it was with the twin goals of revolutionising consumer credit and offering a new asset class to investors. Specifically, marketplace operators wanted to make credit more widely available at lower prices – and to enable investors to access new return streams through directly funding unsecured consumer loans.
While they were initially greeted with scepticism, as an industry, online credit marketplaces have exceeded initial expectations in terms of their staying power and growth in market share. In addition to unsecured personal loans, product offerings have expanded to include auto loans, mortgages, and securitized products. The sector has proved its viability as a financing mechanism while in the process birthing a new investable asset class.
Today, marketplace lending facilitates roughly 40 per cent of unsecured consumer loan originations. On top of that, multiple academic studies have showcased its beneficial impacts on consumer credit access., A consumer lending study from the Philadelphia Fed also found that the best credit marketplaces are generally at least as efficient at assessing credit risk as the biggest banks are.
What was the root of the industry’s success? Marketplace lending developed to fill a persistent unmet consumer need, namely accessing credit at an affordable rate. This goal appealed to individual investors from the outset, who were an early and consistent source of capital, and remain so today. Even as institutional investors have entered the space en masse, retail investors continue to be important players in the marketplace lending ecosystem. Their ongoing attraction to the asset class speaks to the important role it plays in their portfolios, namely as a means of realizing potentially competitive returns and diversifying their portfolios. It also reflects how much investing has changed since the pre-financial crisis era.
Investing has shifted substantially since 2007
The first marketplace lenders arrived on the scene just as the wheels nearly came off the bus of the global economy. The financial crisis, which saw double-digit percentage declines in equities, shook investors’ faith in traditional financial markets. Three developments have unfolded since: a huge shift toward lower-cost investing strategies; increasing democratisation of investing markets that has opened up new avenues for individual investors; and greater investor emphasis on aligning their investments with their values., Marketplace loan platforms have benefitted from and helped drive, investor interest in new asset classes and new methods of accessing them.
Demanding lower-cost products
Having witnessed active managers fare no better, or perform even worse, than market indexes in the aftermath of the 2008 market meltdown, professional and retail investors alike, shifted toward low-cost investment funds and away from complex, high-fee products. The popularity of passive and index investing can be understood in that context. According to Morningstar, passive funds represented 20% of U.S. equity assets under management (AUM) in 2007. Today passive funds account for close to 50 per cent of assets in domestic stock funds, and they are making inroads in fixed income as well. This shift has not been confined to the U.S. either. The shift to lower-cost and passive investing strategies is on the rise globally.
I expect this trend to continue for two reasons. First, low interest rates have been one of the defining characteristics of the post-financial crisis investment markets. As a result, investors are reaching beyond traditional asset classes for yield. Second, this low-return context only heightens investor focus on fees. Growing fee-consciousness has driven investment fees down by roughly 40 per cent since 2009. Schwab’s recent decision to eliminate fees for online stock trades, which E*TRADE and others quickly matched, is only the latest indicator this trend will continue.
Marketplace loans as an asset class benefit from the same factors driving investors to low-cost, typically index funds, namely a desire to access relatively easy to understand, low-fee investments.
Democratising investing markets
As investors have shifted from active to passive investing strategies, and from higher-fee to lower-fee products and strategies, they have been met with an explosion in the number and array of products available across asset classes and product categories. For instance, exchange-traded funds (ETFs) were introduced in the late 1990s. But the past 10 years has seen new players, funds, and asset classes added to the product category. And thanks to the emergence of new investing channels such as credit marketplaces and robo-advisors, retail investors have more, cheaper, and easier ways to access new assets as well.
Marketplace lending’s technological innovation has not only improved borrowers’ access to credit, it’s also allowing investors to conveniently access a different asset class. They can choose securities tailored to their risk tolerance. This marriage of broader investment access and convenience speaks to today’s more fee-conscious investor.
Investing with their values
The third major development is the acceleration of values-driven investing. As a case in point, funds dedicated to environmental, social, and governance (ESG) strategies reached $12 trillion AUM in the U.S. in 2018, up from roughly $200 billion in 2007. Retail investors control 25% of that figure and are key to the category’s continued growth. The rise of B Corporations, businesses certified as meeting performance standards around social and environmental conduct, is another example of this motive. Certified B Corps have surged in number, from under 200 in 2006, to more than 2,500 as of last year, as investors and consumers push companies to be more transparent and engage with all their stakeholders. And where retail investors lead, institutional ones often follow. B Corps are seeing interest and investment from venture capital firms. As Larry Fink, BlackRock’s CEO, put it earlier this year, “Society is increasingly looking to companies, both public and private, to address pressing social and economic issues.”
Of course, it’s not just about doing good. Retail investors not surprisingly, are primarily focused on returns. But millennial investors in particular, who came of age amid the rise of the “sharing economy,” place importance on aligning everything from their food to their clothing to their careers to their investments with their values. They also express a desire to diversify across different types of assets. Again, this has implications for marketplace lending.
Retail investors remain a critical engine in helping to close the consumer credit gap and enabling borrowers on their path to financial health. More than that, here at LendingClub they are embedded in our brand DNA. Just as we are committed to enabling consumers’ financial health, we also strongly believe we should offer individual investors access to the same asset classes big institutions can choose from. While our investor mix has changed over time, we continue to view retail investors as a stable funding source. And as the marketplace lending industry continues to develop, we may see even more product offerings tailored to retail investors’ needs.
One last point. When the economy slows investors may favour assets whose returns do not move in lockstep with equities. Marketplace loans’ distinctive features, which include low correlation with traditional asset classes and short duration, coupled with persistent unmet consumer demand across economic cycles, should continue to draw interest.
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