Larry Swedroe: Alternative Lending Has Many Benefits
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Larry Swedroe: Alternative Lending Has Many Benefits
For fans of modern portfolio theory, Larry discusses another investment that can potentially improve portfolio efficiency and move an individual's portfolio a little more towards the northwest corner of the efficient frontier plot. Alternative lending represents direct investment in short term small business, student, and some consumer loans. Alternative lending has potential for equity like returns with low correlation to equities most of the time. This investment should provide a credit premium and a liquidity premium. I believe one can make a position for alternative lending by taking from either equity or bond side of the portfolio; in either case portfolio efficiency should improve. Curious to hear Boglehead thoughts.
Dave
http://www.etf.com/sections/index-inves ... y-benefits
Dave
http://www.etf.com/sections/index-inves ... y-benefits
Re: Larry Swedroe: Alternative Lending Has Many Benefits
My main questions are this: who regulates alternative lenders, what regulation is out there, and to what degree are regulations enforced? Hopefully there is some oversight, I hate to see a "wild west" out there on alternative lending. It also raises questions if Dodd/Frank went too far if it makes smaller business loans uneconomical. But Dodd/Frank is a political issue and beyond the scope of this forum.
It boils down to me what the risks really are. I just remember the securitization of mortgages, really a great idea, but abused. The abuse of this concept was one of the big factors underlying the 2008-2009 financial crisis. A lot of bad mortgages were originated, packaged, sold to investors as investment grade when in reality a lot of it was junk. I am thinking of Freddie Mac and Fannie Mae. The alternative lending is a great idea but I wonder if this will be similarly abused.
I know Larry Swedroe does not like mortgage backed securities, even GNMA's. Alternative lending sounds a lot to me like the securitization of mortgages. Sort of like putting individuals directly into the banking business. Spread the risk from fewer large balance sheets to many smaller balance sheets, I suppose transferring risk from institutions to investors. The difference is in the liquidity of mortgage backed securities vs. the semi-liquid nature of alternative lending. As long as alternative lending stays within the parameters of sound practices, it should be okay. My concern is that the institutions will be tempted to push the envelope. I have concerns about the credit rating of alternative lending instruments as well as the temptation for institutions to deviate from sound lending practices.
There are also concerns about the "run on the bank" problem. I know Stoneridge and other such funds limit liquidity, you can invest or request redemptions only at certain times. The problem is that there is no equivalent to the Federal Reserve to draw on for emergency cash. I am sure this has been well thought through and safeguards installed but it takes a crisis to see if the safeguards will really work.
I get the uneasy feeling that I have seen this movie before.
It boils down to me what the risks really are. I just remember the securitization of mortgages, really a great idea, but abused. The abuse of this concept was one of the big factors underlying the 2008-2009 financial crisis. A lot of bad mortgages were originated, packaged, sold to investors as investment grade when in reality a lot of it was junk. I am thinking of Freddie Mac and Fannie Mae. The alternative lending is a great idea but I wonder if this will be similarly abused.
I know Larry Swedroe does not like mortgage backed securities, even GNMA's. Alternative lending sounds a lot to me like the securitization of mortgages. Sort of like putting individuals directly into the banking business. Spread the risk from fewer large balance sheets to many smaller balance sheets, I suppose transferring risk from institutions to investors. The difference is in the liquidity of mortgage backed securities vs. the semi-liquid nature of alternative lending. As long as alternative lending stays within the parameters of sound practices, it should be okay. My concern is that the institutions will be tempted to push the envelope. I have concerns about the credit rating of alternative lending instruments as well as the temptation for institutions to deviate from sound lending practices.
There are also concerns about the "run on the bank" problem. I know Stoneridge and other such funds limit liquidity, you can invest or request redemptions only at certain times. The problem is that there is no equivalent to the Federal Reserve to draw on for emergency cash. I am sure this has been well thought through and safeguards installed but it takes a crisis to see if the safeguards will really work.
I get the uneasy feeling that I have seen this movie before.
A fool and his money are good for business.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
Okay, good some good information on this from "good authority." This is not my work, I am quoting a knowledgeable source. This answers the questions that I raised.
Few things for you.
The lenders are regulated by various groups including state regulators. but the issue is one of credit
quality. Here no subprime and average credit score about 700, and in 2008 credit card lenders with this profile, in worst UE period since Depression MADE MONEY. Now here yields lower, but so are costs. We think that lendx would have lost about 5% in 08 (partly due to small amount of leverage they use.) Note duration under 1.5 years so much less term/inflation risk with very limited downside
and huge premium over term And NO RISK of run since limited to 20% per year, 5% per quarter and duration is MUCH shorter than that. This is about the best product I've seen new in decades, along with reinsurance.
A fool and his money are good for business.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
I think the article, while interesting, has something confusing & some misleading points. First, there seems to be a mixing up of uncollateralized consumer loans & small business loans. At first, it implies that there should only be investment in business loans but if you are buying whole loans from one of these platforms it includes consumer also. There are 2 issues with small business collateral. First, is the collections process, which is expensive and can eat up more than the interest received & some principal. Second, business that are good cash flowing businesses typically do not require large amounts of loans to operate. This does not even address the issue of performance in a down turn. None of the underwriting platforms have been tested in a downturn to see what the actual performance would be. From my understanding, most of the borrowing on these platforms is still personal credit loans. If this is a great market why not buy the credit card companies whose credit pool is getting better as these alternative platforms are providing credit to the more risky borrowers.
One other concern based upon the comments below is it appears that the author is depending upon structure of the investment, the payback terms to protect him. This was the same fallacy of CDOs. The structure was suppose to save you but what we found out was if you use garbage as an underlying asset (no or poorly collaterized mortgages or consumer debt) then the structure did not save you. Do we not have the same situation here? The collateral here, although short in duration, has unproven characteristics & is constantly changing. If the creditors become more creditworthy they go to lower cost sources of capital, if the stay the same or get worse then they stay with you so you have a large adverse selection selection issue here akin to payday lending.
IMO this area of lending, high interest rate/payday lending, while over short periods of time can be profitable always seems to blow up in the end. The issue is you do not know it has blown up until it is actually happening & the market is illiquid so you are stuck with the decisions you have made in the past.
Finally, the example provided in the article of downside risk is a little silly. Comparing an illiquid pool of loans to a liquid market in stocks does not make sense. They key difference here are the illiquid loans are not marked to market & second the risk in the pool of loans will not show up until the defaults start to happen which will be delayed a few months from any financial crisis.
In general, I find the authors view that somehow this is an inefficient market that is not already exploited unusual as there are thousands of individuals & hundred if not more institutions already here. Also, IMO there are other cheaper ways to access this market, if you want access to this space, then high fee interval funds. BTW with arrival of leveraged institutional investors into this market, the expected returns will be much lower than history when these players were not here.
Packer
One other concern based upon the comments below is it appears that the author is depending upon structure of the investment, the payback terms to protect him. This was the same fallacy of CDOs. The structure was suppose to save you but what we found out was if you use garbage as an underlying asset (no or poorly collaterized mortgages or consumer debt) then the structure did not save you. Do we not have the same situation here? The collateral here, although short in duration, has unproven characteristics & is constantly changing. If the creditors become more creditworthy they go to lower cost sources of capital, if the stay the same or get worse then they stay with you so you have a large adverse selection selection issue here akin to payday lending.
IMO this area of lending, high interest rate/payday lending, while over short periods of time can be profitable always seems to blow up in the end. The issue is you do not know it has blown up until it is actually happening & the market is illiquid so you are stuck with the decisions you have made in the past.
Finally, the example provided in the article of downside risk is a little silly. Comparing an illiquid pool of loans to a liquid market in stocks does not make sense. They key difference here are the illiquid loans are not marked to market & second the risk in the pool of loans will not show up until the defaults start to happen which will be delayed a few months from any financial crisis.
In general, I find the authors view that somehow this is an inefficient market that is not already exploited unusual as there are thousands of individuals & hundred if not more institutions already here. Also, IMO there are other cheaper ways to access this market, if you want access to this space, then high fee interval funds. BTW with arrival of leveraged institutional investors into this market, the expected returns will be much lower than history when these players were not here.
Packer
Buy cheap and something good might happen
Re: Larry Swedroe: Alternative Lending Has Many Benefits
Packer, my "knowledgeable source" which I have on "good authority" did attempt to address your concerns. I raised similar concerns in my first post on the thread and got a response which I reposted.
Your other point that this product is relatively new and really not battle tested is a good one. It boils down to your investment philosophy and whether or not you buy into the thinking behind the alternative investments. The author has recommended things like AQR Style Premia Fund, Reinsurance, Alternative Lending, and Portfolio Insurance. My guess is that these alternatives are about 20% of a portfolio.
I suppose a big market and economic downturn due to catastrophic natural events would hit probably three out of the four recommended areas for alternative investments. Something like the AQR Style Premia fund might pleasantly surprise, the other three would likely be hit hard. What I am trying to say is that you can't protect against everything. If the Norks start lobbing nukes, all bets are off.
Your other point that this product is relatively new and really not battle tested is a good one. It boils down to your investment philosophy and whether or not you buy into the thinking behind the alternative investments. The author has recommended things like AQR Style Premia Fund, Reinsurance, Alternative Lending, and Portfolio Insurance. My guess is that these alternatives are about 20% of a portfolio.
I suppose a big market and economic downturn due to catastrophic natural events would hit probably three out of the four recommended areas for alternative investments. Something like the AQR Style Premia fund might pleasantly surprise, the other three would likely be hit hard. What I am trying to say is that you can't protect against everything. If the Norks start lobbing nukes, all bets are off.
A fool and his money are good for business.
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
I believe in Factor investing; improving portfolio efficiency by diversifying across independent sources of return. I see alternatives like reinsurance and alternative lending as going one step further.
Dave
Dave
Re: Larry Swedroe: Alternative Lending Has Many Benefits
My counterpoint: Prosper and the like were on the bleeding edge ten years ago, and the profile of lenders (a lot of techies, and apparently management of one of the companies) was drastically different than it is today, where it seems to have supplanted or replaced payday loans that have been made all but illegal in many states.nedsaid wrote: ↑Mon Aug 21, 2017 11:06 am Okay, good some good information on this from "good authority." This is not my work, I am quoting a knowledgeable source. This answers the questions that I raised.
Few things for you.
The lenders are regulated by various groups including state regulators. but the issue is one of credit
quality. Here no subprime and average credit score about 700, and in 2008 credit card lenders with this profile, in worst UE period since Depression MADE MONEY. Now here yields lower, but so are costs. We think that lendx would have lost about 5% in 08 (partly due to small amount of leverage they use.) Note duration under 1.5 years so much less term/inflation risk with very limited downside
and huge premium over term And NO RISK of run since limited to 20% per year, 5% per quarter and duration is MUCH shorter than that. This is about the best product I've seen new in decades, along with reinsurance.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
Well, I just reposted from my reliable source. I do have questions about this, which have been raised. I do not own any of the alternative investment products talked about in this thread. Hopefully others with knowledge of the lending business can chime in.Whakamole wrote: ↑Wed Aug 23, 2017 12:09 pmMy counterpoint: Prosper and the like were on the bleeding edge ten years ago, and the profile of lenders (a lot of techies, and apparently management of one of the companies) was drastically different than it is today, where it seems to have supplanted or replaced payday loans that have been made all but illegal in many states.nedsaid wrote: ↑Mon Aug 21, 2017 11:06 am Okay, good some good information on this from "good authority." This is not my work, I am quoting a knowledgeable source. This answers the questions that I raised.
Few things for you.
The lenders are regulated by various groups including state regulators. but the issue is one of credit
quality. Here no subprime and average credit score about 700, and in 2008 credit card lenders with this profile, in worst UE period since Depression MADE MONEY. Now here yields lower, but so are costs. We think that lendx would have lost about 5% in 08 (partly due to small amount of leverage they use.) Note duration under 1.5 years so much less term/inflation risk with very limited downside
and huge premium over term And NO RISK of run since limited to 20% per year, 5% per quarter and duration is MUCH shorter than that. This is about the best product I've seen new in decades, along with reinsurance.
A fool and his money are good for business.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
+1 to the bolded.Random Walker wrote: ↑Wed Aug 23, 2017 11:32 am I believe in Factor investing; improving portfolio efficiency by diversifying across independent sources of return. I see alternatives like reinsurance and alternative lending as going one step further.
Dave
"Alternatives" as an asset class are often IMO an attempt to find non-correlated (or negative correlation if we can all dream) pieces to shoehorn into a portfolio at the margins. I understand the desire, but I don't find anything all that convincing personally.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
This.packer16 wrote: ↑Wed Aug 23, 2017 7:07 am I think the article, while interesting, has something confusing & some misleading points. First, there seems to be a mixing up of uncollateralized consumer loans & small business loans. At first, it implies that there should only be investment in business loans but if you are buying whole loans from one of these platforms it includes consumer also. There are 2 issues with small business collateral. First, is the collections process, which is expensive and can eat up more than the interest received & some principal. Second, business that are good cash flowing businesses typically do not require large amounts of loans to operate. This does not even address the issue of performance in a down turn. None of the underwriting platforms have been tested in a downturn to see what the actual performance would be. From my understanding, most of the borrowing on these platforms is still personal credit loans. If this is a great market why not buy the credit card companies whose credit pool is getting better as these alternative platforms are providing credit to the more risky borrowers.
One other concern based upon the comments below is it appears that the author is depending upon structure of the investment, the payback terms to protect him. This was the same fallacy of CDOs. The structure was suppose to save you but what we found out was if you use garbage as an underlying asset (no or poorly collaterized mortgages or consumer debt) then the structure did not save you. Do we not have the same situation here? The collateral here, although short in duration, has unproven characteristics & is constantly changing. If the creditors become more creditworthy they go to lower cost sources of capital, if the stay the same or get worse then they stay with you so you have a large adverse selection selection issue here akin to payday lending.
IMO this area of lending, high interest rate/payday lending, while over short periods of time can be profitable always seems to blow up in the end. The issue is you do not know it has blown up until it is actually happening & the market is illiquid so you are stuck with the decisions you have made in the past.
Finally, the example provided in the article of downside risk is a little silly. Comparing an illiquid pool of loans to a liquid market in stocks does not make sense. They key difference here are the illiquid loans are not marked to market & second the risk in the pool of loans will not show up until the defaults start to happen which will be delayed a few months from any financial crisis.
In general, I find the authors view that somehow this is an inefficient market that is not already exploited unusual as there are thousands of individuals & hundred if not more institutions already here. Also, IMO there are other cheaper ways to access this market, if you want access to this space, then high fee interval funds. BTW with arrival of leveraged institutional investors into this market, the expected returns will be much lower than history when these players were not here.
Packer
I agree with what you said here and my big concern is that the push of these untested 'alternative' funds is borne of a hope of finding that mystical uncorrelated gem which often leads to taking a naive view of the investment in front of them - and is ultimately bought at a pretty hefty expense.
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
Big red,
Regarding the search for noncorrelated and the dream of negative correlation, I think there's reason to be more optimistic about a few of the investments:
1. Can't fathom reinsurance being correlated to anything: disasters are random events
2. Makes intuitive sense that TS Momentum should perform well in an equity bear
3. Makes intuitive sense for CS Momentum and Value to be negatively correlated
4. Makes sense that although overall stocks and bonds uncorrelated, the correlation turns strongly negative when equity crises hit
Regarding the other correlations between factors, I mostly just put some faith in historical data
Dave
Regarding the search for noncorrelated and the dream of negative correlation, I think there's reason to be more optimistic about a few of the investments:
1. Can't fathom reinsurance being correlated to anything: disasters are random events
2. Makes intuitive sense that TS Momentum should perform well in an equity bear
3. Makes intuitive sense for CS Momentum and Value to be negatively correlated
4. Makes sense that although overall stocks and bonds uncorrelated, the correlation turns strongly negative when equity crises hit
Regarding the other correlations between factors, I mostly just put some faith in historical data
Dave
Re: Larry Swedroe: Alternative Lending Has Many Benefits
My understanding is that a lot has changed in the lending world. Pretty much technology and scale that enable things to be done in a much more efficient way, LENDX can do things that a small community bank could not 30-40 years ago. A lot of this has to do with electronic data and the ability to monitor business cash flows on a daily basis.
A fool and his money are good for business.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
The main issue I have with alternative lending & re-insurance is the aspect of timing. One of the best investors in re-insurance is Buffett. He makes his money not by being exposed to re-insurance risk all the time like the re-insurance funds are but by varying his exposure based upon the price being offered for insurance versus his estimate of losses. On average insurance is a competitive business & on average the combined ratios of insurance companies are greater than 100% so looking for excess return in this market does not sound like an easy thing to do. Just imagine yourself at the table with Buffett or others as smart as him constantly playing the game & hoping to win.
Alternative lending is similar. The guys at Luecadia National were experts in alternative lending. There approach was similar to Buffett's in insurance selectively timing exposure to the markets when the yields were the highest. I am not sure that in alternative lending that there is enough return through the cycles that these alternative lenders go through that have exposure to the whole cycle makes sense.
I am skeptical of the diversification argument because you already have exposure to these assets in your diversified portfolio (alt lenders via credit card companies & re-insurance via insurance companies) so are you not just increasing sector exposure above the market cap weights & how is this different than just overweighting a sector which defeats the advantage of diversification in the first place.
Packer
Alternative lending is similar. The guys at Luecadia National were experts in alternative lending. There approach was similar to Buffett's in insurance selectively timing exposure to the markets when the yields were the highest. I am not sure that in alternative lending that there is enough return through the cycles that these alternative lenders go through that have exposure to the whole cycle makes sense.
I am skeptical of the diversification argument because you already have exposure to these assets in your diversified portfolio (alt lenders via credit card companies & re-insurance via insurance companies) so are you not just increasing sector exposure above the market cap weights & how is this different than just overweighting a sector which defeats the advantage of diversification in the first place.
Packer
Buy cheap and something good might happen
Re: Larry Swedroe: Alternative Lending Has Many Benefits
How is this actionable to a Boglehead? Passive and low cost. It's been years since I looked at Prosper and Lending Club out of curiosity. They were not passive or sufficiently diversified. Diversification does not mean randomization.
Warning: I am about 80% satisficer (accepting of good enough) and 20% maximizer
Re: Larry Swedroe: Alternative Lending Has Many Benefits
I agree with a lot of this. I think buffet and others are willing to play only in relative illiquid markets where they perceive a supply and demand imbalance. That's how they can get a premium yield.packer16 wrote: ↑Thu Aug 24, 2017 6:42 am The main issue I have with alternative lending & re-insurance is the aspect of timing. One of the best investors in re-insurance is Buffett. He makes his money not by being exposed to re-insurance risk all the time like the re-insurance funds are but by varying his exposure based upon the price being offered for insurance versus his estimate of losses. On average insurance is a competitive business & on average the combined ratios of insurance companies are greater than 100% so looking for excess return in this market does not sound like an easy thing to do. Just imagine yourself at the table with Buffett or others as smart as him constantly playing the game & hoping to win.
Alternative lending is similar. The guys at Luecadia National were experts in alternative lending. There approach was similar to Buffett's in insurance selectively timing exposure to the markets when the yields were the highest. I am not sure that in alternative lending that there is enough return through the cycles that these alternative lenders go through that have exposure to the whole cycle makes sense.
I am skeptical of the diversification argument because you already have exposure to these assets in your diversified portfolio (alt lenders via credit card companies & re-insurance via insurance companies) so are you not just increasing sector exposure above the market cap weights & how is this different than just overweighting a sector which defeats the advantage of diversification in the first place.
Packer
In regards to your last paragraph I think the suggestion is not diversification in the sense of gaining exposure to the sector/industry by it's market cap or even over weighting that sector because you think it will outperform the broader market. The idea is it's correlation with the broader market is much closer to 0 than most other sectors that comprise the broader market. So by over weighting it you can decrease the volatility of your portfolio.
I don't disagree, but I'm a skeptic by nature when it comes to new funds that try to capture stuff like this. I will never be confused for an early adopter. I just like to learn about them and monitor.Random Walker wrote: ↑Wed Aug 23, 2017 2:05 pm Big red,
Regarding the search for noncorrelated and the dream of negative correlation, I think there's reason to be more optimistic about a few of the investments:
1. Can't fathom reinsurance being correlated to anything: disasters are random events
2. Makes intuitive sense that TS Momentum should perform well in an equity bear
3. Makes intuitive sense for CS Momentum and Value to be negatively correlated
4. Makes sense that although overall stocks and bonds uncorrelated, the correlation turns strongly negative when equity crises hit
Regarding the other correlations between factors, I mostly just put some faith in historical data
Dave
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
Big red,
I'm a huge believer in market efficiency. I'm sort of skeptical of these things as well. Sort of surprised how I've gone all in
Packer,
I believe the reinsurance and alt Lending are very different from investing in the stocks of credit card businesses or stocks of reinsurance businesses. These are not stocks of lenders or reinsurers, they are direct investments in the businesses. So the investments will be much less correlated with stocks. To give an example, many people consider precious metals a huge diversifier. And some people invest in the stocks of the precious metal mining companies looking for that diversification. But I believe the stocks of those companies behave way more like stocks than they do precious metals. I think the distinction is whether the shares in the investment are traded on a secondary market or not. In the case of Stone Ridge Alt Lending and Reinsurance, they are direct investments in the businesses and there is no secondary market. I believe this is related to the interval fund structure.
Dave
I'm a huge believer in market efficiency. I'm sort of skeptical of these things as well. Sort of surprised how I've gone all in
Packer,
I believe the reinsurance and alt Lending are very different from investing in the stocks of credit card businesses or stocks of reinsurance businesses. These are not stocks of lenders or reinsurers, they are direct investments in the businesses. So the investments will be much less correlated with stocks. To give an example, many people consider precious metals a huge diversifier. And some people invest in the stocks of the precious metal mining companies looking for that diversification. But I believe the stocks of those companies behave way more like stocks than they do precious metals. I think the distinction is whether the shares in the investment are traded on a secondary market or not. In the case of Stone Ridge Alt Lending and Reinsurance, they are direct investments in the businesses and there is no secondary market. I believe this is related to the interval fund structure.
Dave
Re: Larry Swedroe: Alternative Lending Has Many Benefits
All of these segments of the market are already available to investors & the marketing spin that some have put on these segments IMO is misleading. If you want exposure to the alternative lending market loans there are tons of credit ABS out there that have all kinds of collateral including student loans, credit card receivables, long term leases etc. Like most new things in finance they are old things put into a new package & sold for a higher fee.
Re-insurance risk can be gained by buying cat bonds. My bigger question with these markets is: does it make sense to own them over the long term. These markets are analogous to high yield debt in that most successful investors are invested only occasionally not over the long term. What I am surprised at is Larry does not like junk bonds but likes these investments that have similar high timing risks. BTW SCV investing has the same timing risks. I think this timing risk is real & can only be diversified away by holding more of a market portfolio which reduces the effectiveness of the tilt so I skeptical that either tilts or these old/new asset segments will add much to portfolios beyond volatility, akin to adding a sector fund to a diversified portfolio.
Packer
Re-insurance risk can be gained by buying cat bonds. My bigger question with these markets is: does it make sense to own them over the long term. These markets are analogous to high yield debt in that most successful investors are invested only occasionally not over the long term. What I am surprised at is Larry does not like junk bonds but likes these investments that have similar high timing risks. BTW SCV investing has the same timing risks. I think this timing risk is real & can only be diversified away by holding more of a market portfolio which reduces the effectiveness of the tilt so I skeptical that either tilts or these old/new asset segments will add much to portfolios beyond volatility, akin to adding a sector fund to a diversified portfolio.
Packer
Buy cheap and something good might happen
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
Packer wrote
So I wouldn't mitigate risks of reinsurance or Alt Lending by putting big heavy bet on single factor TSM, I'd do it by diversifying across as many potential sources of return as possible.
Dave
There is another way to look at this. Since any one factor / source of return can underperform for a long time, it is best to diversify across as many potential sources of return as possible. Sometimes people say something like "I have a shorter timeframe, I may not be able to wait to see SCV pay off, therefore I'll go TSM only". I think this is backwards as well. Over a shorter timeframe we don't know which factors will perform well and which won't (including market beta). Thus the shorter the timeframe, the more it would make sense to diversify across factors / sources of return. Check out Larry's factor book. Near the end is a table or two that shows how each factor can underperform for significant periods, but he also shows that 1/n portfolios diversified across the factors mitigate this risk tremendously.BTW SCV investing has the same timing risks. I think this timing risk is real & can only be diversified away by holding more of a market portfolio which reduces the effectiveness of the tilt so I skeptical that either tilts or these old/new asset segments will add much to portfolios beyond volatility, akin to adding a sector fund to a diversified portfolio
So I wouldn't mitigate risks of reinsurance or Alt Lending by putting big heavy bet on single factor TSM, I'd do it by diversifying across as many potential sources of return as possible.
Dave
Re: Larry Swedroe: Alternative Lending Has Many Benefits
Hi Packer,packer16 wrote: ↑Fri Aug 25, 2017 6:35 am Re-insurance risk can be gained by buying cat bonds. My bigger question with these markets is: does it make sense to own them over the long term. These markets are analogous to high yield debt in that most successful investors are invested only occasionally not over the long term.
Larry discusses cat bonds vs something like Stone Ridge's Reinsurance portfolio here:
-glarryswedroe wrote: ↑Mon Dec 05, 2016 7:59 am Just a thought for you.
CAT bonds have performed well and they are logical investments with a risk premium and unique risk that is uncorrelated to anything.
With that said, the ZRP has led to a stretching for yield and that has driven prices of all assets with yield way up and expected returns down. That's one issue.
The other is that I would be careful here. We looked at CAT bonds and considered them for years and decided to pass as yields had come way down and they are concentrated (though uncorrelated) risks of basically US hurricanes. I would prefer a broad globally diversified basket of reinsurance risks across risks like hurricances, tornados, flood, fire, property and casualty, event risks, etc. That is what reduces the otherwise large tail risks when you have concentration. That's why I have invested in SRRIX
Larry
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
And I believe Buffett has sharply scaled back? Did he not comment that with many hedge funds doing reinsurance, the profits just are not there any more?packer16 wrote: ↑Thu Aug 24, 2017 6:42 am The main issue I have with alternative lending & re-insurance is the aspect of timing. One of the best investors in re-insurance is Buffett. He makes his money not by being exposed to re-insurance risk all the time like the re-insurance funds are but by varying his exposure based upon the price being offered for insurance versus his estimate of losses. On average insurance is a competitive business & on average the combined ratios of insurance companies are greater than 100% so looking for excess return in this market does not sound like an easy thing to do. Just imagine yourself at the table with Buffett or others as smart as him constantly playing the game & hoping to win.
Certainly as personal investors we will not be nimble. Does Luecadia National (merged with Jeffries, the investment bank?) still do well in this area?Alternative lending is similar. The guys at Luecadia National were experts in alternative lending. There approach was similar to Buffett's in insurance selectively timing exposure to the markets when the yields were the highest. I am not sure that in alternative lending that there is enough return through the cycles that these alternative lenders go through that have exposure to the whole cycle makes sense.
Not sure about the latter. This is a different asset class. More like an income trust, to my mind.I am skeptical of the diversification argument because you already have exposure to these assets in your diversified portfolio (alt lenders via credit card companies & re-insurance via insurance companies) so are you not just increasing sector exposure above the market cap weights & how is this different than just overweighting a sector which defeats the advantage of diversification in the first place.
Packer
But I am wary of fat tails and/or skewed returns.
I always get this wrong, but a distribution which has a hump to the right of the mean line is "left skewed"? I.e. there is a higher possibility of loss than a Normal distribution would get you-- of a zero or negative return?
That seems to be the problem with reinsurance. That you can, as the result of a random event, lose your entire investment?
Alternative lending I am just not sure. Whilst I can see the genuine social benefit that is created here-- access to credit for people and businesses that would not otherwise get credit*, I worry about adverse selection. In other words, that the higher risk borrowers will use this platform, and that will not be detectable until we go through a full credit cycle.
In both cases (alternative lending and reinsurance) it strikes me it's hard to see why the small investor would do well, when there are big players in the market, who presumably have access to better information and risk assessments.
* and direct access for investors to those borrowers. This opens up the possibility of a bank run, because there is maturity transformation here. The solution is that the lending platform can impose liquidity constraints. So we should earn a higher return than money in the bank or in a bond fund, because we could go illiquid on this investment in a crisis.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
This really gets to investment philosophy and schools of thought. I think of it like this:
1) Are you a do-it-yourself investor or do you invest through an advisor?
1a) Do you take a hybrid approach, some do-it-yourself and some through an advisor?
2) Do you believe that an investor can beat the market? If so, you are probably interested in active management and/or factor investing. If not, you will probably stick to the broad indexers.
3) Are you open minded enough to venture beyond plain vanilla stock and bond investments?
4) Are you willing to sacrifice liquidity in exchange for (hopefully) higher returns?
5) Do I trust even carefully selected advisors with fiduciary status?
For me, at this point in time, my answers would be hybrid, yes the market can be beat, no I want traditional investments, no I don't want to sacrifice liquidity, and maybe I might trust an advisor.
So based on all of that, I am not a candidate for things like alternative lending, reinsurance, portfolio insurance, and hedge funds for the masses. So far, I have chosen the tried and the true and the liquid investments. My thinking might change at some point but that is where I am now.
It would be a waste of time for me to invest with Larry Swedroe's firm and then fight the advisor every step of the way on choice of investments and asset allocation. There needs to be an alignment in philosophy between advisory firm and the client.
1) Are you a do-it-yourself investor or do you invest through an advisor?
1a) Do you take a hybrid approach, some do-it-yourself and some through an advisor?
2) Do you believe that an investor can beat the market? If so, you are probably interested in active management and/or factor investing. If not, you will probably stick to the broad indexers.
3) Are you open minded enough to venture beyond plain vanilla stock and bond investments?
4) Are you willing to sacrifice liquidity in exchange for (hopefully) higher returns?
5) Do I trust even carefully selected advisors with fiduciary status?
For me, at this point in time, my answers would be hybrid, yes the market can be beat, no I want traditional investments, no I don't want to sacrifice liquidity, and maybe I might trust an advisor.
So based on all of that, I am not a candidate for things like alternative lending, reinsurance, portfolio insurance, and hedge funds for the masses. So far, I have chosen the tried and the true and the liquid investments. My thinking might change at some point but that is where I am now.
It would be a waste of time for me to invest with Larry Swedroe's firm and then fight the advisor every step of the way on choice of investments and asset allocation. There needs to be an alignment in philosophy between advisory firm and the client.
A fool and his money are good for business.
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
Nedsaid,
I overwhelmingly agree with you. I've gone the advisor route though, and will disagree on one point. The invested money is always the client's, and the consequences of investment decisions are the client's as well. So a good advisor only presents options and makes recommendations. There shouldn't be a struggle between advisor and client. Rather advisor should understand the client's philosophy and perhaps advise within that framework.
Dave
I overwhelmingly agree with you. I've gone the advisor route though, and will disagree on one point. The invested money is always the client's, and the consequences of investment decisions are the client's as well. So a good advisor only presents options and makes recommendations. There shouldn't be a struggle between advisor and client. Rather advisor should understand the client's philosophy and perhaps advise within that framework.
Dave
Re: Larry Swedroe: Alternative Lending Has Many Benefits
My best guess is that for an advisor/client relationship to really work well, you need to have an 80% or higher alignment in philosophy. It just won't work if I have a Value orientation and go to a firm that is oriented to Growth. It is what I call "getting with the program." But yes, a firm to a degree will customize to a client but it would be a waste of time for a client to want a Taylor Larimore Three Fund portfolio at Buckingham. Pretty much at Buckingham, you need that factor religion. At Vanguard, it is that old buy and hold the broad indexes religion. If you were a factor investor and went to Vanguard Advisory Service, at best you would get a half-hearted attempt at factor tilting, if they would agree to doing that at all. Plus Vanguard does not have the best products for tilting. There is also the fact that an advisory firm needs some economy of scale. They can't do Three Fund for some folks, factor tilting for others, and individual stocks for yet a third group.Random Walker wrote: ↑Fri Aug 25, 2017 3:42 pm Nedsaid,
I overwhelmingly agree with you. I've gone the advisor route though, and will disagree on one point. The invested money is always the client's, and the consequences of investment decisions are the client's as well. So a good advisor only presents options and makes recommendations. There shouldn't be a struggle between advisor and client. Rather advisor should understand the client's philosophy and perhaps advise within that framework.
Dave
A fool and his money are good for business.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
I think the whole factor model is flawed in that the market factor is like white light (a combination of all factors weighted by the market) and value momentum, re-insurance & alt lending just different colors. So when you factor invest you are betting that the market has is it wrong in terms of relative valuation weights. Over short periods of time this may be true & thus many of these strategies were an outgrowth of hedge fund trading strategies not long term investment strategies.
Case in point is the value factor. Non-quant value funds determine the value of a security doing a complete fundamental analysis much more research & detailed than a value factor as defined by quants/academics. If you look at the composition of most value factor funds most active value managers would not invest in them as they are on average leveraged & in poor economics industries.
I think an important aspect of factors & alternative sources of return is there uniqueness. Part of the assessment is to determine if the source is available somewhere else & if so how & at what price. You also need to assess the marketability of the investment. So for things like re-insurance which is available via Berkshire Hathaway or Markel at a lower cost plus an expert at when to be exposed to the market, the appeal of a high fee always exposed to the market has little appeal. Now if the alternative was liquid I could see some utility but the funds I have seen are not so what is the advantage? Just for yuckes I compared a composite of Berkshire & Market to a broadly based insurance index and the Stone Ridge re-insurance product. The result, Market & Berkshire beat the index by 5% per year and re-insurance product lagged the index by 3.2%. Some may say this gives you equity exposure (with BH and Markel you get good stock pickers for free) but if you are locked into a fund anyway does if make any difference other than in theory? IMO The same holds true for alternative lending.
Packer
Case in point is the value factor. Non-quant value funds determine the value of a security doing a complete fundamental analysis much more research & detailed than a value factor as defined by quants/academics. If you look at the composition of most value factor funds most active value managers would not invest in them as they are on average leveraged & in poor economics industries.
I think an important aspect of factors & alternative sources of return is there uniqueness. Part of the assessment is to determine if the source is available somewhere else & if so how & at what price. You also need to assess the marketability of the investment. So for things like re-insurance which is available via Berkshire Hathaway or Markel at a lower cost plus an expert at when to be exposed to the market, the appeal of a high fee always exposed to the market has little appeal. Now if the alternative was liquid I could see some utility but the funds I have seen are not so what is the advantage? Just for yuckes I compared a composite of Berkshire & Market to a broadly based insurance index and the Stone Ridge re-insurance product. The result, Market & Berkshire beat the index by 5% per year and re-insurance product lagged the index by 3.2%. Some may say this gives you equity exposure (with BH and Markel you get good stock pickers for free) but if you are locked into a fund anyway does if make any difference other than in theory? IMO The same holds true for alternative lending.
Packer
Buy cheap and something good might happen
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
I am curious where you found the return data on the Stone Ridge product. I have not been able to find any reliable source. The return data I have seen from Portfolio Visualizer and other sites does not factor in distributions. Since the Stone Ridge products distribute all of their income, every source I have looked at so far is just garbage.
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Re: Larry Swedroe: Alternative Lending Has Many Benefits
I too am curious where to find the return data on the Stone Ridge funds.
Dave
Dave
Re: Larry Swedroe: Alternative Lending Has Many Benefits
When information is hard to find, EDGAR is always a good option as you can find the annual/semi-annual reports there:
https://www.sec.gov/Archives/edgar/data ... oc338701_1
From inception (2/1/2013) through the latest year-end (10/31/2016), the reinsurance fund returned 6.3% per year.
I will leave it to other to cherry-pick their preferred comparisons to show that it either over/under-performed.
https://www.sec.gov/Archives/edgar/data ... oc338701_1
From inception (2/1/2013) through the latest year-end (10/31/2016), the reinsurance fund returned 6.3% per year.
I will leave it to other to cherry-pick their preferred comparisons to show that it either over/under-performed.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
One other surprising piece of trivia I learned from Googling around on this--I wasn't expecting to see that their reinsurance funds would have an AUM of $5B.
Re: Larry Swedroe: Alternative Lending Has Many Benefits
I found the data on Bloomberg & did the comparative returns using BB's tools. Another aspect of investing in re-insurance and alt. lending is the competition. One of the reason given for excess returns for active was unsophisticated investors to take advantage of. In alt. lending this was the case early on so some nice returns could be made but both markets are now populated by professionals so I am not sure that a passive fund with higher fees than professional funds, the case of the equity alternatives & re-insurance, are going to do better or different than the alternatives.
Packer
Packer
Buy cheap and something good might happen