Portfolio update june 2018

It’s been a long while since I’ve done a portfolio update and a lot has changed, so I thought I’d share! Definitely some huge changes within the last year in terms of asset classes and I’ve had to make many changes to be more liquid to be ready to finance my new home (which will hopefully be finished in October).

Real estate is now pretty much gone from my portfolio. If you remember, I owned a small 12m2 dorm room style apartment in Northern Tallinn, which offered reasonable returns, but was also the most illiquid investment in my portfolio. Due to ridiculous price growth and lack of time and enthusiasm to manage the property, I sold it at the start of the year, cashing out a solid 20%+ yearly return, so overall not bad. Any exposure I have towards real estate now is real estate fund stocks and crowdfunding projects.

The rest of my portfolio is currently divided up between the stock market and P2P investments, with stock market investments totalling 25% of my investments and P2P investments 74%. The missing 1% is random trivia not worth mentioning here.

Stock investments are mostly single stocks from the baltic stock market, a total of 83.5% of stock investments or a total of 21% of portfolio, and some index fund investments, which total 16.5% or a total of a bit over 4% of total portfolio.

From the Baltic market positions which are bigger (more than 5% of total portfolio) are TKM (Tallinna Kaubamaja) and SAB (Šiauliu bankas), some smaller positions are in LHV (LHV bank), Tallink and the just-IPO’d Tallinna Sadam and a few tiny positions of SAF, TEL, APG, Merko, Eften. This is the lazy money I keep in my portfolio, mostly to buy and keep forever.

For index positions, these are currently much smaller than usually since I’m waiting for my home purchase to be finalised to finally start building an international portfolio, so it’s half invested into the third pension pillar (LHV Indeks pluss) and the rest is in a convenience index investing product that I’ve left ticking for tax reasons, kasvukonto (has a bit of EXSA, VAL, SPYW).

Social lending and crowdfunding are currently the core of my portfolio due to their high liquidity and current high returns. After years of testing through many different sites, I’ve kept only three among my investments, maybe will add a fourth when more finances free up or these shrink up (as Omaraha is currently).

Biggest portion of P2P investments are via Mintos, which is currently a whopping 40% of my portfolio, mostly due to the cashback and super fast secondary market. This is where my new home’s furniture money is currently earning interest.

Second biggest position, which has however been shrinking is Omaraha. Due to lower loan volumes and drops in interest rates, the effective returns are way below what they were even last year, and I’ve been slowly transferring money out to stop if from just sitting there. Will see how it goes. Currently at 24.5% of portfolio and slowly decreasing.

Last position is my higher risk part of the portfolio, investments into real estate developments mostly, which is Crowdestate. This houses a bit less than 10% of my total portfolio, however growth isn’t particularly fast since there aren’t too many projects. This is about the level I intend to keep this investment at.

There you go, current overview! At the end of the year I will have to liquidate some investments due to high expenses associated with hope purchasing, but hopefully once I sell the current home I’ll be able to patch up the damage and have a chance to add some new assets.

 

Omaraha loan volumes and interest rates

For a significant amount of time Omaraha was one of the P2P lending sites that offered highest returns. This was largely due to the way their auction system worked – investor could essentially bid how much money they were willing to invest into a loan and at which rate. The system started filling the loans from bottom up (lowest to highest rate) and then the person taking out the loan got an average rate based off those.

This meant that if you kept an eye on how the loans got financed you could get into loans at ridiculously high interest rates while the borrower could still get a reasonable total rate. Best example of this is probably in the 7- and 10-year loans which have been removed by now, where investors were rather shy to commit, meaning you could get into loans at the max rate allowed – 60% gross (48%net for investor). This was also possible for 5-yr loans.

or

All good things must come to an end though, and the 7-yr and 10-yr loans were removed (largely due to the total rates failing to comply with the legal max interest rate limits) and the cap for max interest rates was also brought down, so you could no longer make autobidders with such insane rates. Good for the borrowers, sad for the investors.

Current situation

Somewhat as a result of those changes the average interest rates started to come down. A section of borrowers disappeared from site (those who got higher rate loans, but were no longer able to), and since the site itself had become much more popular among investors and the total available cash number kept increasing (up to 1mil at times), which started to push down the average rates.

As a result the drop has actually been rather immense. Another contributor has probably been the fact that Omaraha has elected to be less of a black box – before you had to take the time to figure out the interest rates yourself, now, however they show you the maximum rates that offer a chance to get into loans. Today’s stats:

rates

As it stands, since the buyback rate offered (used to be at 80% for a long time) has started to slide back closer to 60%, then clearly the squeeze is two-fold both less security in buyback and lower interest rates. Since they’re also reduced the max amount per loan that an investor can contribute, this makes previous strategies much harder to use as well (it’s no longer as efficient to “ladder” interest rates for separate autobidders).

As a result Omaraha has dropped to somewhere in the middle of the pack when it comes to returns with one significant downside – lack of a secondary market, which means making an exit is much more difficult than on some other sites. As a result, for the first time in two years I’ve actually taken out some money since it started to build up too much.

 

How many P2P portals to include in your portfolio?

Since there is a significant amount of P2P portals now available compared to a few years ago, the question quickly arises – how many portals should you include in your portfolio? Is it better to focus on just a few portals, or should you attempt to diversify and reduce risk by including a large amount of portals? How does this change when the total sum of your investments gets bigger? Are there downsides to diversifying?

My current P2P portfolio

As time has moved, my P2P portfolio has changed a lot. I started, like many others with 100% Bondora, but have now completely exited it. I also tried Moneyzen, Viventor and Estateguru, which I’ve also not kept in my portfolio. It definitely took me a while to figure out a selection I like, and it’s constantly changing in time. Currently the balance is as follows:

Screen Shot 2017-07-17 at 12.47.32

P2P investments currently make up 47% of my whole investment portfolio. This means, that from my total portfolio the rates are: OR 24%; CE 13%; Twino and Mintos ~5% each. As you can see the exposure to Omaraha is rather big, the exposure to other portals is significantly less.

Liquidity

As with all investments, something to consider is liquidity. With P2P investments liquidity mostly comes from two aspects – firstly the length of the projects/loans (for example Twino’s 1-3 month loans vs Omaraha’s 5 year loans) and secondly the availability of a secondary market (and the speed of trading there).

For me, I’ve decided that for now, liquidity is not a huge priority for me, which means that I’ve allowed my portfolio to move towards longer term locked-in projects. Omaraha does not have a secondary market, and while defaulted loans have a sell-back function, it’s still a rather long term investment. CrowdEstate is also a long-term prospect, since while the projects are generally 1-2 years in length, the portal has a right to extend the projects and there is no secondary market to allow for an exit.

However, a part of my portfolio I’ve still kept rather liquid and this part is carried by Mintos and Twino. With both of these portals, I can easily pull out money from in a matter of days, so if for some reason I need to move money to another investment, or have need for cash, then this portion of my portfolio allows me to do this.

Risk

Now, assessing risk is a tricky thing in the P2P business. While you can look at overall history of the portals, a lot of them are new enough to not have much of a track record. Both Twino and Mintos in theory should be relatively low risk, however since Mintos has at least one loan originator that’s in trouble (and might go bankrupt), it’s clear that things can still go wrong.

The most ‘stable’ part of my P2P portfolio is probably Omaraha, due to the length of experience they have, and the overall stability of the market. However, Omaraha is also prone to all kinds of radical changes (such as the interest cap instated last week), which means that the portal risk itself might influence your long term strategy.

Crowdestate is clearly the most risky part of my P2P portfolio at this point, due to both the type of investments (mostly real estate development projects) and the risk of the real estate market overheating. This means that I will not really allow the volume of investments to increase too much there, I’ve mostly hit the point where I reinvest returned money, and add in less than I used to.

Time expense

With every new P2P portal that you add, there is both an investment of time and money. You need to invest time to figure out how this particular portal works, and how to achieve the best results. Depending on the portal this might require quite a bit of tinkering. For example, Omaraha has been offering great returns, but the time investment in managing interest rates there was also quite a bit of work. In comparison to Mintos or Twino, where you could pretty much just cruise by, using the autobidder function.

Since I invest though my company account, then any new portal also means more bookkeeping, and additional tracking. This means that there isn’t really much point in adding in a portal just to put a couple of hundred of euros into it, it becomes reasonable to add in another portal once the investment is in the thousands already. This means that while I’m currently at 4 portals, it’s not unreasonable to add in a fifth, there just has to be a reason for it – either it offers some different level of liquidity; there is a significantly different risk profile (different sector, country etc.), or an attractive risk-reward ratio.

How have you divided up your investments?

Fraudulent loans in P2P – Omaraha example

One of the inherent risks of the lending business is the likelihood of fraud happening. People will always be motivated to try to get loans and not pay them back, and this isn’t something that’s limited to P2P – banks and other credit providers constantly try to improve their systems to stop fraud from happening.

However, when it comes to P2P a lot of portals have been rather tight-lipped about giving out any actual statistics for loan fraud, which is strange in the sense that it’s unlikely that no fraud has occurred. I remember from when I started out with Bondora, then the forums occasionally discussed some fraudulent applications, since back then it was possible to track the people you gave loans to because a lot of the borrower’s info was public.

Since then, when looking at Bondora defaults, then for quite a few you can see marked as “criminal proceedings started”, which implies fraud, whether it was giving false data, using someone else’s ID etc. For an investor this means that unless you are phenomenally lucky then you will at some point lose a bit of money to fraud.

Omaraha, the Estonian P2P portal had an interesting case happen, which hasn’t gotten a lot of attention, and to be honest if people weren’t diligent about their portfolios then I’m not sure if it ever would have been public info. Essentially, there was a dozen or so loans that were given out to Latvian borrowers, which in all likelihood used either fraudulent data or some other tricks to get through the system.

Obviously, it’s reasonable for Omaraha not to give out exact details which workaround was used to trick the system, but the fact being – in the range of 50 000 euros (+/- 10K) was lost to this one wave of fraud. Due to the way Omaraha’s system works, 80% of that will be absorbed by the recovery fund, and 20% will be lost for the investors. I was one of the people who managed to get lucky and hit quite a few of those loans with my autobidder, so I’ll be taking a loss in the range of 100 euros from this venture.

Now, why this is important other than the fact that it’s of course sad to lose the money; is the fact that this is an inevitable part of investing in to loans. No system is absolutely foolproof, and workarounds will be found. As an investor it’s your job to take that into account when planning your strategy  – the knowledge that at some point such losses may happen. For portals this is always something that would be nice to transparently explain, to provide investors with more confidence in the due diligence they do.

Buyback for P2P loans, how does it work?

When choosing a P2P platform to invest into, buyback has become a significant vote in favour of some sites. Others, however, are a bit suspicious and wonder how guaranteed return makes economic sense. This is a topic that I get a fair bit of questions about, and I was in the camp of those wondering where the catch was at start as well. However, this is the reason you do background checks – to figure out how the economic model of certain sites works and whether or not it makes sense.

Different options of buyback

Currently I invest on three different P2P sites that offer a buyback option. The Latvian sites Twino and Mintos offer a buyback campaign that purchases back delinquent loans. For Mintos the deadline is 60 days, for Twino the deadline is 30 days delinquent. (This seems to be a bit earlier at times, since I’ve been seen buybacks from both sites already.) The Estonian site Omaraha also offers a kind of a buyback – for them it’s a principal buyback in the value of ~60% of the remaining principal. Both Twino and Mintos however also pay out the interest you have earned. So, in theory for both of those sites it’s as near to guaranteed return as it can get in P2P, how does it make financial sense?

How do the numbers work?

The biggest question that you should be asking when it comes to buyback is this – how does the business still make a profit? This is the key issue – they have to be making profit off the loans otherwise the buyback would not be sustainable in case of an economic downturn. This means that despite the fact that some of the profits earned off loans are paid out to investors, the business still earns some.buyback For both the Latvian sites the % you earn is in the ranges of 12-15% return on a yearly basis. This means that clearly the actual loan rate for the people taking out the loans has to be significantly higher to justify such a payout model. For Twino the loans are payday loans, meaning the interest rates are likely to reach up to 100%, for Mintos some of the loans are for example car loans, that are likely to go up to 30% per year. In addition to the overhead interest any and all penalties, extra interest and fees are also placed on top of the interest that you earn as an investor. This means that buyback is viable only for loans that have a high enough margin for the loan originators to cover (un)expected losses and wait for recovery to happen on defaulted loans. For Omaraha the interest rates on certain groups aren’t too high, which explains the buyback being partial – allowing a return of only a part of the principal. Bondora for example is against buyback on principal, but theoretically it could be implemented with good data workings provided they were interested in doing even more of the recovery (which they are not at this point in seems). Another important note here is the length of the loan – for Twino getting investors involved would be near impossible without buyback due to the short term of the loans, since waiting for recovery would be disproportionately long compared to the loan terms on the site.

Risks associated with buyback

In the world of consumer credit it’s common for companies to finance themselves using investors’ money. This is how most SMS-loan type businesses work – they release bonds at about 10-12% rates that finance their loan origination. Compared to the buyback process (and financing loans through the marketplace with investors’ money) releasing bonds is actually rather expensive – take into account all the fees for lawyers, documentation etc. Plus, financing the loans through a marketplace allows the businesses only use as much of the supply as they need, meaning they don’t pay out interest on money that’s still not used, actually probably making offering the buyback cheaper than other methods of financing their loan portfolio.

However, this does not eliminate risks completely. Firstly, in case of the loan originator going under you’re still in trouble. Secondly, even with the best laid plans, issues might happen – for example in case of a crisis buyback may be (temporarily) cancelled. Thirdly, this is an untested way of financing – issues may occur that none of us have been able to predict.

This means that you should still firstly diversify between different loan originators, still diversify between loans themselves and diversify across different investments and take a critical look at the background of the originators to see if their financial models work out. However, this might just be something that will take more ground in the world of P2P – reducing risks is one thing that might motivate more risk averse investors to try out P2P investments.