Institutional investors often look at what their peers are doing to inform their investment strategy. Likewise, individual investors often look to large institutions for innovative investment ideas.
Recently, Greenwich Associates, an unaffiliated research company, conducted a study to better understand how marketplace lending is perceived and the current state of adoption within the institutional investing community.
The Greenwich Marketplace Lending research study was conducted from August to October 2017. The study interviewed 74 investors from pension plans and asset managers with a total of over $3.5 trillion in assets to understand how marketplace lending is perceived and the current state of adoption within the institutional investing community. Among the sample, 21 were current investors in marketplace loans and 53 were not.
Below are four takeaways from the study that point to how institutions are considering marketplace lending investments.
Sixty-seven percent of institutional investors cited the higher yield that marketplace loans tend to offer as their primary reason for investing. Diversification and low correlation to other asset classes, efficient access to a new asset, and low volatility were also identified as important factors driving the decision to invest (see below).
Institutions already investing in marketplace loans are satisfied with their experience, with 57% planning to increase allocations.
Marketplace loans are unique assets. They share some characteristics with short maturity bonds and high yield bonds (as those assets typically mature in either three to five years and offer a higher coupon). For this reason, many investors reported thinking of marketplace loans as part of their fixed income portfolio, as replacements for individual bonds or bond funds. At the same time, when packaged into a securitized product (where assets are pooled and then sold as a single security), marketplace loans can resemble structured products, such as asset-backed securities (ABS). Other institutional investors who purchase whole loans (rather than fractions or securitized pools of loans) reported comparing the assets to bank or leveraged loans.
Because marketplace loans can be used for many different reasons, one of the first questions that investors may face when considering marketplace loans is how to categorize them. For over two-thirds of surveyed institutional investors currently invested in MPL (see chart below), they fall in the category of structured products, putting them alongside ABS and collateralized loan obligations (CLOs). Almost half of current investors reported viewing them as short-duration instruments and one-third as high-yield bonds.
Almost 40% of institutional investors who are not yet invested in marketplace loans said they didn’t know how to characterize them. This suggests that while early adopters are finding value using marketplace loans in a range of portfolio applications, the potential for future adoption is still vast as more investors become aware of the asset class.
Survey respondents indicated greater institutional investor adoption will be driven by three primary catalysts:
Because the earliest marketplace loan securitizations were not rated by major bond rating agencies, many institutional investors were reluctant to invest initially. Since mid-2017, however, each new issuance was rated by at least one rating agency, removing this obstacle and further broadening exposure to the asset class.
Investors deeply value data and analytics, which are key to understanding the credit profile of borrowers on marketplace lending platforms.
While the secondary market for marketplace loans is illiquid, there is a more active secondary market for the securitized offerings.
Current and potential investors also indicated there are a few obstacles that need to be overcome before initiating an investment in marketplace loans. Chief among them is getting comfortable with the idea of performance during a downturn. While several platforms have a multi-year track record, and a few platforms like LendingClub began before the financial crisis, investors have less data upon which to draw strong conclusions about downturn performance.
Over the past 10 years, marketplace lending has established its relevance as an innovative way for investors to access a new asset class. The next decade will decide whether the industry moves from being a niche investment to the mainstream. A majority of current investors, 52%, believe that marketplace lending will be a significant player in the financial system in the next 10 years. This is another meaningful vote of confidence in the industry.
For more information on how LendingClub could fit into your long term investment strategy, check out this post on 5 strategies for using LendingClub Notes.
LendingClub was not involved in performing the study summarized above and cannot verify the accuracy of the statistical information contained within.