Thursday, June 25, 2015

4 Things about Crowd Lending

AK recently talked about this in his post titled "To make 20% per annum, we could lose our capital".
Richard Ng from Invest Openly also gave an open review of MoolahSense which is a crowd lending platform.

Now it is my turn to share my thoughts about this topic.

First and foremost, it is important to understand why crowd lending exists in the first place. From what I understand, crowd lending exists because there is a natural market for it.

Some businesses need loans and they are (1) either no able to obtain a loan from the bank or (2) the cost of the loan is too expensive.

Then there are lenders who do not want to "lend" the bank money for fixed deposit kind of interest rates. Some of these lenders are more aggressive and do not mind to take risks to get higher returns. Risk of course being the loss of capital.

The idea of crowd lending exists because it brings together lenders who are willing to lend money out to businesses to collect a higher return (with risks involved) with businesses who want to get loans at a cheaper cost of financing.

Secondly, the deal is not actually "too good to be true". Whether it is on purpose or not, MoolahSense amortizes its loans which allows them to display the amortized rate. I'm not going to teach finance here, but basically the amortized number is a lot higher than a straight-up, plain vanilla bond.

Take for example, the current MoolahSense campaign for Leap Networks. They "rate" being offered is 20%. However, the 20% is the amortized rate. If it was a plain vanilla bond, the actual return or YTM is 11.61%. Wow, big difference right? You can check this yourself using an amortization calculator.

I'm not saying that companies like MoolahSense and CapitalMatch are shady companies for shrugging off "guarantees" of returns. Equity investors don't blame SGX if their equity investment turns bad, why should we hold debt marketplace makers to a different standard?

The risk of losing your money investing in debt is real, just like how you can lose your money investing in equity. To think expect otherwise is really just being ignorant of the investment.

Thirdly, you must understand that you are investing in debt, not equity.

Most investors by default are only used to and have more experience in equity investing and not debt investing, other than the current FCL retail bond offering which have now turned everyone into bond gurus. The main difference is that equity investors like to focus on "returns on capital (equity)". The 3 letter acronym ROE gets thrown all over the place. Equity investors like to focus on future earnings and growth and other things, which can be less meaningful to the debt investor.

However, crowd-lending, as its name clearly suggests, is investing in debt. Most debt investors focus on "return of capital". Herein lies the huge disparity between debt and equity investors. The more confident that a debt investor is certain that he will get back his capital, the lower rate he is willing to tolerate.

One must understand that he does not participate in any of the upside of the company should it do well. Evaluating a debt investment requires looking at a different set of things compared to an equity investment.

Fourthly, you must understand the risks of investing in debt.

The biggest risk is that you might get back absolutely nothing. Of course, you need to weigh the probability of that happening and decide for yourself if it is worth it to take such risks.

All asset classes have pros and cons and are different from each other. These differences allows certain strategies to work better on some asset classes compared to others.

I did consider to invest in the Seoul Yummy campaign that MoolahSense was doing a while ago, but in the end I decided not to. I am not invested in any of these crowd lending campaigns, but I honestly would consider whatever they have to offer. Like all deals, there are good deals and bad deals.

4 comments:

  1. With less than a few years of track record, perhaps it's better to wait a few years and see how this turns out. Perhaps a more mature and proven market by then?

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    Replies
    1. Yes, I would like to see the current campaigns end and see how the company and investors felt about it!

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  2. With a minimum investable amount of $1000 for each listing, those with lots of spare cash can also diversify across 10, 20 or even 30 loans or more to reduce risk.

    On a separate note, I find it interesting that Leap Networks has launched another crowdlending initiative so soon after its (successful) loan request on CapitalMatch.

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    Replies
    1. Hey J,

      Agreed that $1000 in each listing will definitely reduce risk. There doesn't seem to be much choices though!

      Ah, interesting! I did not know they raised funds on CapitalMatch earlier! Doesn't sound too good to me if that is the case!

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