If you want to test yourself as an analyst, decide that technology is going to change the investment business, and then set out to understand exactly how.
There are a number of trends that cross over from technology. AirBnB, now effectively one of the world’s largest hotels, owns none of the real estate it offers. Uber has gained immense market share by streamlining the annoying process of getting a cab… and by the way, they don’t employ any drivers.
Will the investment services of the future use no money? It’s not a crazy question. Some of the highest profile financial technology companies operate on precisely that premise. So-called “marketplace” lenders, like Lending Club and On Deck Capital, aim to bring suppliers and consumers of capital together on the same platform, set appropriate interest rates based on risk, and service the loans throughout their lives.
These companies have grown immensely, but to critics they still have a lot to prove. Today Lending Club and On Deck Capital change hands for less than 35% of their IPO prices, and there is a reason for that. The institutional investors who were funding the loans made by these platforms have gotten less enthusiastic about supplying capital. And that means the lenders’ business models will need to evolve. As Fitch Ratings puts it, the firms are confronting “market realities.”
Optimism was once at a fever pitch. About eighteen months ago, I spoke with four different funds in a single week who all had more than a quarter of their portfolios invested in Lending Club loans. This was surprising, since they were as different as one could imagine, and hadn’t done much else in credit until finding the platform. But it was easy to use, and offered them an exposure that was hard to find elsewhere without going through scores of intermediaries.
So we have two realities that apply to the same companies: passionate users with good reasons to like the product, and stock charts that go from top left to bottom right. What the heck is going on? Should we be worried about the future of this category?
Ashby Monk, executive and research director of the Stanford Global Projects Center, considered this question a few weeks ago in Institutional Investor. His answer: “Nah.” The thinking is that what we’re seeing is really growing pains as marketplace lenders evolve to find more stable pools of capital to support themselves. As many have learned over time, counting on continued favor from the hedge fund community is a great way to be disappointed.
In contrast, large institutional investors can be slow slow to embrace change, but think in decades and centuries. They are also continuously looking to deploy capital and increasingly attentive to the fees their intermediaries feast upon.
So, it makes sense that pension funds looking to invest in loans would seek out ways to invest in them directly. The experience of the firms that have come to market so far may not actually tell us much about the validity of that premise, since a sufficiently large fund might even set up their (fully vertically integrated) program with its own constraints and objectives. Success then becomes somewhat personal, and difficult to judge from the comfort of your keyboard.
It’s not without irony that this version of the financial future is rather apart from the one brought to us by Uber and AirBNB. For one thing, what we are contemplating is a world where technology services employ a tremendous amount of their own capital. For another, this is just one possible future.
At the 69th CFA Institute Annual Conference, delegates will consider this future in a session on How Technology Will Change the Business of Investing.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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