Part 2 of the series on alternative sources, this one on alternative lending

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larryswedroe
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Part 2 of the series on alternative sources, this one on alternative lending

Post by larryswedroe »

http://www.etf.com/sections/index-inves ... nopaging=1

Another simple, not complex, product that basically puts you in the banking business (on the right side, as lender not borrower) without the infrastructure costs just as the reinsurance product put you in that business on the right side without infrastructure costs.

Hope you find it helpful
Larry
EzM
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by EzM »

Hi Larry, thanks for posting.

Can you highlight why owning the typical reinsurers, or financial services and credit card companies in the public equity space is not good enough for capturing these premiums in a portfolio?

What is the major draw in using Stoneridge instead, besides the costs and regulation differences?
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larryswedroe
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by larryswedroe »

EzM
As I explained ---re reinsurance, our first thought was to just buy the reinsurers to get access to that risk. But the problem is that gives you also big exposure to market beta as well, which we don't want. So the next thought was to hedge that risk out, and short beta while owning the reinsurers. But that leaves you also with basis risk and you can lose on both sides. So with that we think the best way to access the risks is to own quota shares which gives you exposure to globally diversified portfolios of risk covering dozens of different types of risk (while CAT bonds, a cheap way to play in that space, gives you mostly US hurricane risk and concentrated, and you also lose the illiquidity premium). It's basically a simply and straightforward product that focuses on getting beta exposure to these risks and no attempt to get alpha (as many hedge funds in this space do by selecting which risks to buy).

For the same reason you would not want to buy the equities of the alternative lenders.

And obviously this is space where you want highly experienced people who can negotiate the quota share agreements and manage the risks appropriately. That leads to the choice of the fund manager you want to choose.

I hope that is helpful
Larry
psteinx
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by psteinx »

Once again, we have two funds with, err, elevated expense totals:

First up, RiverNorth Marketplace Lending Corporation...

Drumroll please...

And the fees & expenses are:

... 0.5%?

Nah, try higher

... 1.0%?

Nope, guess higher

... OK then, 1.5%? That's pretty steep.

You're getting (somewhat) warmer

... Hmm, 2.0%?

Keep going.

... OK, I give - what're the damages?

A mere 2.70%. (see page 22).

But wait, if you act NOW, you can take advantage of a 30bp fee waiver, dropping the total to a mere 2.4%. Fee waiver for first 2 years. After that, unless, I presume, the manager agrees, you're back up to the full 2.70%.

(That's per the unlevered example in the 497 filed on the SEC site. There is also a levered example with some interest costs and some slightly different #s (overall, a touch higher). The prospectus on RiverNorth's website also gives the numbers. There may be minor differences in the prospectus's detailed explanations and the like, but they seem basically the same as the 497's.)

========

...Hmm, OK, so maybe that fund is a touch pricey. Well, how bout Stone Ridge's fund - maybe it's cheaper?

Nope, it's not cheaper. Think MORE expensive than the Stone Ridge product.

...Hmm, more than 2.7%? So like 3%, right?

Almost there

...OK, I give up, just tell me.

Fair 'nuff. LENDX has total fees & expenses of 3.37%, plus interest on their leverage (estimated at 1.07%), less a 27 bp fee waiver. (Prospectus, page 24). No clear duration that I could see on the fee waiver, but the example costs on page 24 apparently only assume the fee waiver for the first year.

Also, as with the other Stone Ridge product discussed in the other thread, it appears that to access LENDX, most retail investors would need to be going through an advisor. (See the relevant tab here). So, if you're not already using an advisor, add estimate AUM costs for that. I think it's not unreasonable to assume fees for a high 6/low 7 figure portfolio as typically being >= 0.75% per annum. It appears the RiverNorth product can be bought without an advisor.

Note that the numbers listed above do not all go to the advisor(s) (Stone Ridge & RiverNorth), but include various expenses, including, notably, loan servicing fees that are presumably charged by the lending platforms. If you were to invest directly on the platforms (Lending Club or whatever, I'm guessing), then you'd presumably be paying those fees yourself, and probably a somewhat higher figure than whatever Stone Ridge & RiverNorth have negotiated. Almost all lending to consumers, whether by these new channels, or by more traditional players like banks, is ultimately going to bear costs for servicing the loans, and so an apples to apples comparison to alternatives would make appropriate adjustments.

If interested, please have a look at the expense breakouts included in the relevant documents.

Disclaimer: I'm not your hired advisor, I'm not doing your due diligence for you. I did some quick research on these products this morning, and may have missed all kinds of things, made mistakes, etc.
Last edited by psteinx on Fri Apr 07, 2017 12:04 pm, edited 2 times in total.
aristotelian
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by aristotelian »

psteinx wrote:Once again, we have two funds with, err, elevated expense totals:

First up, RiverNorth Marketplace Lending Corporation...

Drumroll please...

And the fees & expenses are:


A mere 2.70%. (see page 22).
And $1M minimum investment. A little bit out of my price range.
aristotelian
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by aristotelian »

EzM wrote:Hi Larry, thanks for posting.

Can you highlight why owning the typical reinsurers, or financial services and credit card companies in the public equity space is not good enough for capturing these premiums in a portfolio?

What is the major draw in using Stoneridge instead, besides the costs and regulation differences?
Better yet, what about buying Lending Tree stock? Wouldn't you be buying a piece of their entire portfolio of peer to peer lending?
psteinx
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by psteinx »

From a less snarky angle:

These funds are clearly expensive. Even if you disregard the servicing fees, the management fees and various other expenses are still high.

Banks have their own costs. The pre-existing model is that a bank uses some capital, runs branches that draw in cheap additional funds (leverage), then lends that money out. The mix of how banks lend, and to whom, of course varies, and will probably have more of a business tilt than these new alternative lending platforms.

A general issue with this new approach is that you take what had been, at least in some cases, ONE entity responsible for the whole cycle of lending:

1) Identify and qualify loan applicants
2) Choose who to lend to, at what terms
3) Service the loans, follow up on delinquencies
4) Reap the profits of good efforts at steps 1-3, and the losses of poor efforts

And divides it 3 ways.

A bank basically does all of 1-4.

In the new model, Lending Club (say), does 1, does part of 2 I think (the terms), and 3, but not really 4
Stone Ridge, managing LENDX (say), does part of 2 (thumbs up or down on applicants, but I don't know if it can set the terms), none of 1 or 3 (beyond choosing partners to work with ), and not really 4
The investor gets 4.

So you've got split interests and multiple agents. Lending Club and Stone Ridge may each have incentives to spend a little less and or exercise less diligence in their domains, because they're not capturing the full profit or loss from good screening and customer/delinquency follow up efforts.

Yes, the same issue can sometimes affect banks, especially when they securitize loans, but I think it's a more intense problem in this new alternative space.
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larryswedroe
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by larryswedroe »

Few things,

Aristolean
Again you are betting on their management of the business, not on the credit spread premium. Not at all the same thing.


Re psteinx comments, as I already explained in other threads on this topic, the ER in the prospectus is literally nonsensical and doesn't reflect reality. The cost of the River North product is nowhere near the 2.7% Psteinx states as it includes service fees which are not reflective of the fund expenses. They are the fees the servicer of the loan keeps in order to compensate for servicing the loan. Just like with an MBS. And of course interest expense if any (which is offset by interest income so not really an expense in way you think about it, the fund doesn't earn that expense)

Second, again this is not like buying an index of stocks of some asset class and you need people who are basically running a bank. So your expenses will be higher. The all in expenses are well below 2%. And SR is around that 2% currently, and expect it to fall somewhat as AUM rises. Also re SR, which is important issue. The fund only charges its management fee on the UNLEVERAGED assets, which make up say 70% of the fund. They don't charge any management fee on the leveraged assets. So you are getting about $1.40 of investments with returns and paying fees on only your $1 investment. So if you prorate that 2% the actual costs on your invested dollars is quite a bit lower.

So it actually helps to understand and perform due diligence so you can make an informed decision.

Remember while costs matter they aren't the only consideration except if the product is a pure commodity, like an index fund, and here they are clearly not pure commodities. Personally I cannot think of a better fixed income investment now for tax advantaged accounts and literally all of my tax advantaged assets are in LENDX and SRRIX, in about 2:1 ratio.


Best wishes
Larry
dave_k
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by dave_k »

What is the least expensive way to purchase LENDX or SRRIX in an IRA? Are there any advisors that can provide access to these without doing any active advising, and charge very minimal fees or fixed (non-AUM) fees? What are the minimums for these funds?
stlutz
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by stlutz »

Can you highlight why owning the typical reinsurers, or financial services and credit card companies in the public equity space is not good enough for capturing these premiums in a portfolio?
I think describing these as "alternative" investments is causing confusion, as "alternative" typically means going long and short on a hodge-podge of different things, levering the portfolio 5x, and then throwing in some high fees.

Suppose I want to make money from the restaurant business. One way to do so is to buy the stocks of companies like Chipotle. Another option is to open my own restaurant. Instead of running it myself, I'd just pay somebody else to run it--so I'm just providing capital and then collecting the profits after everyone gets paid. "Opening a restaurant" is akin to River North/Stone Ridge are doing here.

When I buy a restaurant stock, yes I get dividends from the profits earned by the company, but the price of the stock can fluctuate for any number of reasons that seem very unrelated to what the company is doing at the exact moment. Britain exits the EU and Chipotle's stock goes down. Somebody puts out a tax proposal that would reduce corporate taxes. The proposal isn't yet enacted and wouldn't take effects for 3 years, but the stock goes up now. If you just have a restaurant, you buy raw food items, pay someone to cook them and someone to serve them etc. and then keep whatever money is left over. The other random factors don't play a role in your take-home profit at all.

These funds aren't really "alternative" sources of return. Instead they are removing a bunch of the factors that would drive the return of the stock of a reinsurance company or a lender. Instead, they just pool the assets of a bunch of people and issue reinsurance contracts and pay those people the proceeds. What reinsurance is making is the *only* factor in the returns being earned; everything else is removed.

Because these aren't regular mutual funds, the costs are going to be higher and are necessarily so, as you're paying somebody to run a business for you as opposed to just issuing a buy and sell orders.

The question is whether removing all of the other factors that drive the return of a stock are a necessary thing. From Larry's perspective it is. From other threads (particularly the ones on sustainable withdrawal rates), it's clear that Larry is quite pessimistic on longer term equity returns. And returns on safe fixed income continue to be quite low as well. With his view of the world it is necessary to look for different ways to make money. Removing the whole equity/stock market component and just directly owning the restaurant, rental home, P2P loans etc. may be a better way to go if equity valuations are way too high.

For those who are less pessimistic about the stock market as a whole, this search seems entirely unnecessary. I'm personally in this camp, but Larry's view is a completely legitimate one.

My main disagreement with Larry on the few threads we've had on this topic is that his presentation on the risk of the investment tends to be quite different from that of the firm actually running the product. Stone Ridge etc. say these are risky investments. As such, I would consider these to be alternatives to equity investments as opposed to alternatives to CDs.
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larryswedroe
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by larryswedroe »

Dave
First, either Stone Ridge product must be purchased by an advisor approved by Stone Ridge through them on behalf of the investor, and they can only be bought on certain dates. LENDX is once a month with advance notice (think several weeks) and SRRIX just three times per year (Jan, March and May if memory serves, as those are months when insurance contracts written).

Inside of 401k plan cannot be bought unless have self directed brokerage account and that is due to rules about must having daily liquidity to be in a 401k plan. But can buy in an IRA of course. I did an inkind transfer out of my 401k and into my IRA as I am over 59 1/2 and able to do so. That enabled me to own the fund in lowest cost way in terms of transaction fees related to the 401k---in my case one time $50.

What an advisor charges is an individual thing. So cannot help you there.

Other points
I think describing these as "alternative" investments is causing confusion, as "alternative" typically means going long and short on a hodge-podge of different things, levering the portfolio 5x, and then throwing in some high fees.
This certainly isn't true as alternatives don't necessarily have anything to do with long shorts, nor leverage nor necessarily even high fees.
it's clear that Larry is quite pessimistic on longer term equity returns.
I have no idea how anyone could draw that conclusion. A globally diversified market like portfolio does have lower than historical expected returns but mainly because US valuations now forecast about a 2-3% lower than historical real return, but the rest of world valuations are about historical averages, so I don't now how that can be called quite pessimistic. I am assuming that these two funds will return in the 6-8% range, so equity like returns but with far less downside risks and far less volatility and little to no correlation in most cases. And note the expected return is AFTER fund expenses for the funds.
Stone Ridge etc. say these are risky investments.
Well yes they are risky investments, and that wording is what SEC requires of course. And certainly not SUBSTITUTE for CDs, but as alternatives (not sub) to CDs--in the case of LENDX, absolutely. Now you get much higher expected return, with much shorter duration and thus much less inflation risk, but trade off liquidity and some downside risk, but far from equity like risk, as greatest loss I would estimate to be under 10% which is small fraction of worst case for stocks. SRRIX should not be viewed as substitute for CDs, either.

With that said for those with high equity allocations I would recommend taking the allocation to these alternatives from the equity side as they should produce similar returns but greatly dampen portfolio volatility. So say 60% or higher. For those with very low equity allocations and the stomach to accept some more risk, but not equity like risk, then you can CONSIDER taking from bond side (as I did) as expected returns are much higher and it will increase portfolio vol by much less than expected returns as result of diversification benefits and far less than equity vol. So say that would hold for those with less than 40% equity. And if in between might take it pro rata.

I hope the above is helpful
Larry
Last edited by larryswedroe on Sat Apr 08, 2017 7:39 am, edited 1 time in total.
wije
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by wije »

larryswedroe wrote:First, either Stone Ridge product must be purchased by an advisor approved by Stone Ridge through them on behalf of the investor, and they can only be bought on certain dates. LENDX is once a month with advance notice (think several weeks) and SRRIX just three times per year (Jan, March and May if memory serves, as those are months when insurance contracts written).
Larry, what's the typical minimum for investing in LENDX or SRRIX?
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larryswedroe
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by larryswedroe »

wije
There is no minimum
Larry
Phil DeMuth
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by Phil DeMuth »

Larry --

Great article, thanks!

I've heard that some ETFs have applied to get into this space. If so, they would be creating a market in these loans and the illiquidity would go away. Do you think this is likely to happen? My guess is not anytime soon or BAM wouldn't be jumping in.

Thanks,

Phil
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larryswedroe
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by larryswedroe »

Phil
I don't see how it's even remotely possible to make multi-year loans and have daily liquidity for a fund. It has to be closed end in some way.
Larry
wije
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by wije »

larryswedroe wrote:There is no minimum
Larry, thanks for answering but let me change my wording: What minimum do most RIAs require to invest with them?
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nedsaid
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Re: Part 2 of the series on alternative sources, this one on alternative lending

Post by nedsaid »

stlutz wrote:
Can you highlight why owning the typical reinsurers, or financial services and credit card companies in the public equity space is not good enough for capturing these premiums in a portfolio?
I think describing these as "alternative" investments is causing confusion, as "alternative" typically means going long and short on a hodge-podge of different things, levering the portfolio 5x, and then throwing in some high fees.

Suppose I want to make money from the restaurant business. One way to do so is to buy the stocks of companies like Chipotle. Another option is to open my own restaurant. Instead of running it myself, I'd just pay somebody else to run it--so I'm just providing capital and then collecting the profits after everyone gets paid. "Opening a restaurant" is akin to River North/Stone Ridge are doing here.

Nedsaid: The "Opening a restaurant" analogy sounds about right to me. I suppose it would also be analogous to private equity. By owning the "restaurant" directly and in an illiquid form, the argument is made that you are getting the benefits of ownership without market beta or the risk of the stock market itself. You might also be able to be able to avoid some regulatory costs that a public company would have.

When I buy a restaurant stock, yes I get dividends from the profits earned by the company, but the price of the stock can fluctuate for any number of reasons that seem very unrelated to what the company is doing at the exact moment. Britain exits the EU and Chipotle's stock goes down. Somebody puts out a tax proposal that would reduce corporate taxes. The proposal isn't yet enacted and wouldn't take effects for 3 years, but the stock goes up now. If you just have a restaurant, you buy raw food items, pay someone to cook them and someone to serve them etc. and then keep whatever money is left over. The other random factors don't play a role in your take-home profit at all.

These funds aren't really "alternative" sources of return. Instead they are removing a bunch of the factors that would drive the return of the stock of a reinsurance company or a lender. Instead, they just pool the assets of a bunch of people and issue reinsurance contracts and pay those people the proceeds. What reinsurance is making is the *only* factor in the returns being earned; everything else is removed.

Because these aren't regular mutual funds, the costs are going to be higher and are necessarily so, as you're paying somebody to run a business for you as opposed to just issuing a buy and sell orders.

Nedsaid: I suppose one could say that regular mutual funds have the higher costs too since the costs of running businesses are figured in the profit calculation. It is just in a mutual fund, you have the costs of hundreds of businesses imbedded rather than just one.

The question is whether removing all of the other factors that drive the return of a stock are a necessary thing. From Larry's perspective it is. From other threads (particularly the ones on sustainable withdrawal rates), it's clear that Larry is quite pessimistic on longer term equity returns. And returns on safe fixed income continue to be quite low as well. With his view of the world it is necessary to look for different ways to make money. Removing the whole equity/stock market component and just directly owning the restaurant, rental home, P2P loans etc. may be a better way to go if equity valuations are way too high.

For those who are less pessimistic about the stock market as a whole, this search seems entirely unnecessary. I'm personally in this camp, but Larry's view is a completely legitimate one.

Nedsaid: It would seem to me that if one is pessimistic about domestic stock returns, why not venture overseas into International Developed Markets which are very similar to the U.S. but cheaper? Why not venture into International Emerging Markets which appear to be dirt cheap right now? One could still get equity returns without sacrificing liquidity.

It looks like what Larry is suggesting is getting closer to the actual source. Rather than own a bunch of businesses in a fund and take on market beta as well as business risk, just own the business in a more direct fashion and not be exposed to market risk or beta. My argument is that illiquidity gives the illusion of price stability, an illiquid investment fluctuates in value too, it just isn't so apparent as you don't see the price posted daily on an exchange.


My main disagreement with Larry on the few threads we've had on this topic is that his presentation on the risk of the investment tends to be quite different from that of the firm actually running the product. Stone Ridge etc. say these are risky investments. As such, I would consider these to be alternatives to equity investments as opposed to alternatives to CDs.

Nedsaid: I would put reinsurance and alternative lending in the equity part of the portfolio. These are ideas worthy of consideration but I am cautious and believe that these ideas need more testing in real life markets.
A fool and his money are good for business.
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