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Diversification 101 in Marketplace Lending

account diversification

How Diversification Can Impact Returns in Marketplace Lending

Disclaimer: Lending Club is not a registered investment adviser, and this article is not intended as investment advice. Be sure to consult your financial or investment adviser prior to investing.

Diversification is a simple but fundamental investing concept that spreading your invested dollars across a variety of assets helps to reduce exposure to any single investment. Or put differently – don’t put all your eggs in one basket. Diversification is a key to building a portfolio of Lending Club Notes. As historical Lending Club data show, 98% of accounts that hold 100 or more Notes of relatively equal size have seen positive returns.†

What is a Note?

A Lending Club Note is a unique asset that corresponds to fractions of loans issued to borrowers through the Lending Club platform. A Note entitles the holder to payments that correspond to its pro rata share of principal and interest payments made by the borrower on the corresponding loan. In other words, as a borrower makes payments on their loan, Lending Club makes payments on all Notes that correspond to that loan. The payments made on a Note are entirely dependent on the payment activity of the borrower on the corresponding loan. However, this means that if a borrower stops making payments or defaults on a loan, Lending Club stops making payments on corresponding Notes.

While loans are issued in amounts between $1,000 and $40,000, Notes can be purchased for as little as $25. This can allow investors to:

  • Tailor their investment amount to their preferred level
  • Reinvest returned principal and interest payments into Notes more quickly
  • Diversify their Lending Club portfolio across a variety of Notes

Why Diversify?

Through Lending Club investors are able to access the consumer credit asset class, which has historically been available only to large institutions. But investing in this asset class involves the risk of loss through borrower defaults. It is inevitable that some borrowers will default on their loans, and because Note payments are dependent on borrower loan payments, this means that some Notes will default.
Diversifying your Note portfolio can help to reduce the impact of a single loan default on your returns. A portfolio that purchases Notes in small denominations and spreads those Note purchases across different loans and borrowers, this reduces their exposure to any single loan or borrower.

Consider a Lending Club portfolio that has $2,500 to invest in Lending Club Notes. You could invest:

  • $2,500 in one borrower; or
  • $25 in 100 different borrowers.

If you invested $2,500 in only one borrower and that borrower becomes late and the loan eventually charges off, you could potentially lose 100% of your total investment amount. If you invested $25 in 100 different borrowers your potential loss on any single Note would be limited to 1% of your total investment amount.‡

Tracking the Impact of Note Diversification

NAR by percent of investors

The chart above5 shows the difference between accounts that have 100 Notes or more (with no Note representing more than 1% of the total account value) and those that have fewer than 100 Notes (with some Notes representing more than 1% of the total account value). Historically, 98% of investor accounts who hold 100 or more notes of similar size have seen positive returns.

The chart below6 demonstrates that based on historical data, greater diversification (i.e. owning a higher number of Notes across different borrowers) can reduce volatility in returns. Looking left to right, the chart illustrates how returns can be more stable and consistent in accounts with a higher number of Notes. This occurs because as accounts own more Notes each individual Note represents a smaller portion of the total, reducing the impact of any single Note on the overall returns of the portfolio.

adjusted net annualized return

Through Lending Club, investors can build a diversified portfolio of Lending Club Notes to help reduce exposure to default risk of any single loan or borrower. Lending Club Notes have historically delivered average annual returns of 5% to 7%.7 Investors should review the risks and uncertainties in the Prospectus prior to investing, and should consult with their financial advisor.

This information is not intended to be investment advice. Lending Club Notes are not guaranteed or insured, and investors may lose some or all of the principal invested. Notes are offered by prospectus filed with the SEC and investors should review the risks and uncertainties described in the prospectus prior to investing. Investors should consult their financial advisor with questions or if they need additional information. Actual results may vary.

†As of March 31, 2017. Based on adjusted net annualized return (Adjusted NAR) of current retail investors with a portfolio containing 100+ Notes, none of which have been purchased or sold on the Folio Investing Note Trading Platform**, where the portfolio concentration is one percent or less (i.e. no Note constitutes greater than one percent of the total portfolio value) and the portfolio has a weighted average age of at least 12 months (weighted based on the dollar value of each Note relative to the total dollar value of the portfolio, where the age of each Note is measured as of the purchase date of such Note). Adjusted NAR is calculated using the formula described here. This information is not intended to be investment advice. Historical performance is not a guarantee of future results. Actual results may differ materially from historical data. Lending Club Notes are not guaranteed or insured, and investors may lose some or all of the principal invested. Individual portfolio results may be impacted by, among other things, the size and diversity of the portfolio, exposure to any single Note, Borrower, or group of Notes or Borrowers, as well as macroeconomic conditions. Notes are offered by prospectus filed with the SEC and you should review the risks and uncertainties described in the prospectus prior to investing in the Notes.**Folio Investments, Inc. (“Folio Investing”) is a registered broker-dealer and member of FINRA and SIPC and operates the Note Trading Platform. Folio Investing is based in McLean, VA and is not affiliated with Lending Club. Folio Investing has no role in the original issuance of the Notes and is not responsible for and does not approve, endorse, review, recommend or guarantee the Notes or the accuracy, reliability, or completeness of any data or information about the Notes. See the Important Disclosures page for additional important information. More information about Folio Investing is available at www.folioinvesting.com.

‡ This information is not intended to be, nor should you interpret it to be, a prediction of how a particular portfolio will actually perform. You should always carefully consider investments in any security and you should be comfortable with your understanding of the investment. You may also consider consulting investment professionals.

1Adjusted NAR is a return measure that models potential losses on a loan prior to that loan being charged off. Adjusted NAR is calculated using the formula described here. It is based on monthly borrower payments actually received net of Lending Club’s fees, actual charge offs, recoveries, and estimated future losses. To estimate future losses, we apply a loss rate estimate to the outstanding principal of any loans that are past-due but not charged off. The loss rate estimate is based on historical charge off rates by loan status over a 9-month period. Historical returns are not a promise of future results. Lending Club Notes are not insured or guaranteed and investors may have negative returns. Individual portfolio results may be impacted by, among other things, the size and diversity of the portfolio, exposure to any single Note, borrower or group of Notes or borrowers, as well as macroeconomic conditions.

290th Percentile represents that 90% of retail investor accounts have Adjusted NAR at the end of the most recently completed quarter that is less than or equal to this value.

3Median represents that half of retail investor accounts have current Adjusted NAR that is less than or equal to this value.

410th Percentile represents that 10% of retail investor accounts have current Adjusted NAR that is less than or equal to this value.

5As of March 31, 2017. Based on adjusted net annualized return (Adjusted NAR) of the following populations: (1) current retail investors with a portfolio containing 100+ Notes, none of which have been purchased or sold on the Folio Investing Note Trading Platform**, where the portfolio concentration is one percent or less (i.e. no Note constitutes greater than one percent of the total portfolio value) and the portfolio has a weighted average age of at least 12 months (weighted based on the dollar value of each Note relative to the total dollar value of the portfolio, where the age of each Note is measured as of the purchase date of such Note) and (2) current retail investors with a portfolio containing less than 100 Notes, none of which have been purchased or sold on the Folio Investing Note Trading Platform*, where the portfolio concentration is greater than one percent (i.e. some Note(s) constitute greater than one percent of the total portfolio value) and the portfolio has a weighted average age of at least 12 months (weighted based on the dollar value of each Note relative to the total dollar value of the portfolio, where the age of each Note is measured as of the purchase date of such Note). Adjusted NAR is calculated using the formula described here. This information is not intended to be investment advice. Historical performance is not a guarantee of future results. Actual results may differ materially from historical data. Lending Club Notes are not guaranteed or insured, and investors may lose some or all of the principal invested. Individual portfolio results may be impacted by, among other things, the size and diversity of the portfolio, exposure to any single Note, Borrower, or group of Notes or Borrowers, as well as macroeconomic conditions.

6As of March 31, 2017. Based on adjusted net annualized return (Adjusted NAR) as of the end of the most recently completed quarter for active retail investor accounts that hold at least 50 Notes, none of which have been purchased or sold on the Folio Investing Note Trading Platform** and the portfolio has a weighted average age of at least 12 months (weighted based on the dollar value of each Note relative to the total dollar value of the portfolio, where the age of each Note is measured as of the purchase date of such Note). Data shown is based on intervals of ownership of 50 Notes (i.e. aggregate return figures are illustrated for accounts owning 50-100 Notes, 100-150 Notes, and so on). Adjusted NAR is calculated using the formula described here. This information is not intended to be investment advice. Historical performance is not a guarantee of future results. Actual results may differ materially from historical data. Lending Club Notes are not guaranteed or insured, and investors may lose some or all of the principal invested. Individual portfolio results may be impacted by, among other things, the size and diversity of the portfolio, exposure to any single Note, Borrower, or group of Notes or Borrowers, as well as macroeconomic conditions.

75.01% – 7.38% average historical returns for loan grades A through C as of March 31, 2017. To be included in the historical returns (“Historical Returns”) calculation, a Note must have been originated prior to June 30, 2015. Historical Returns are Lending Club’s adjusted net annualized returns (“Adjusted NAR”) for Notes with Grades A through C. Adjusted NAR is calculated using the formula described here. Historical returns are based on actual borrower payments received each month, net of fees, actual charge offs, recoveries, and estimated future losses. To estimate future losses, we apply a charge-off rate estimate to the outstanding principal of any loans that are past-due but not charged off. The charge-off rate estimate is based on historical charge-off rates by loan status over a 9-month period. Historical performance is not a guarantee of future results. Lending Club Notes are not insured or guaranteed and investors may have negative returns. Individual portfolio results may be impacted by, among other things, the size and diversity of the portfolio, the exposure to any single Note, borrower or group of Notes or borrowers, as well as macroeconomic conditions. Notes are offered by prospectus filed with the SEC and investors should review the risks and uncertainties described in the prospectus prior to investing in the Notes.

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