What’s Your Risk Ratio?
Zach explains an easy metric to help understand the risk profile of your p2p portfolio.
Many investors want to know why it may be beneficial to utilize the services of a third-party investment manager for their peer to peer portfolio.
There are two key reasons investors should consider a third-party investment manager – especially within the peer to peer lending industry. All of which stem from one core issue – alignment of incentives. Think about it, peer to peer marketplaces have to balance the needs of both borrowers and investors to facilitate loans. Since marketplaces like Lending Club and Prosper collect more than 80% of their revenue from origination fees charged to borrowers, they are most concerned with originating loans to collect revenue.
Make no mistake, Lending Club and Prosper do value investors of all kinds and realize that they need to also provide a healthy risk-adjusted return to those who invest in their loans. Therefore, a well-diversified p2p portfolio should produce OK returns.
But why would investors want to settle for OK returns, when you could get good or even great returns?
This leads me to reason number one…Independent Credit Review. Marketplaces make a wealth of data available about borrowers who are seeking loans. Investors analyze this data through tools such as the NSR Platform to make informed investment decisions. For investors who donít use a third-party investment manager, you might be getting the ďleftovers,Ē or the the loans that were deemed high risk by active investors.
Reason number two: downside protection. Iíve seen many investors focus solely on their ROI or return on investment, but another very important metric is their loss rate. This number reflects how much risk youíre taking to achieve a specified return. Right now, in good economic times, we donít notice as much significance of loss rates. However, changes in the broader economy can really impact a portfolio with a high loss rate relative to their overall ROI.
We encourage investors to perform a simple calculation by taking their ROI and dividing it by their loss rate. You can get these metrics for your portfolio by linking your accounts to the NSR Platform here. If that risk/reward ratio is below 1, you should definitely take a second look at your credit strategy.
The bottom line…The cost of an investment manager such as NSR is small, but the benefits are significant – get an unbiased fiduciary thatís on your side! Which means: †independent assessment of credit quality for higher target returns than an index of loans, lower target risk, and independent performance reporting.
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