Part 1: What is a secondary credit model?
Part 2: Investing through LendingRobot
As described in part 1, any future of boosting returns through finding higher performing loans lies in investing via algorithms. And while most of us are not statistical wunderkinds who can construct these formulas ourselves, there are a number of third-party services that can do this for us.
LendingRobot is a low-cost automated investing tool.
One such service is LendingRobot, based here in Seattle. Simply stated, LendingRobot is a low-cost automated investing tool for Lending Club and Prosper. It can invest on your behalf far more quickly and efficiently than if you would invest on your own.
How exactly does LendingRobot improve peer to peer lending? It does it by making the investing process simple and automatic while increasing your returns and offering you a way to liquidate your entire account.
Let’s look at these benefits one by one.
Five Helpful Reasons to Use LendingRobot
#1. Simpler peer lending
Once your Lending Club or Prosper API credentials have been added to LendingRobot, investing is as simple as moving a slider and clicking two buttons. It really is that simple. You don’t even have to learn about loan grades.
The slider is your preferred risk tolerance, meaning how aggressive or conservative you want your investment to be. A more conservative setting places your cash in safer loans while a more aggressive setting places your cash in riskier loans that typically earn a higher return.
Once the slider is set, you simply click Save Strategy and then click your account from Paused to Investing.
That’s it. Your investing is completely taken care of from this point forward.
#2. Automatic reinvestment
LendingRobot will automatically invest in new loans for you within a second of them being added to the platforms, much faster than the automated options at Lending Club or Prosper. This speed means it grabs many loans that these onsite services would have missed or left behind.
Faster automated investing means more of your money is put to work quicker, reducing cash drag and increasing your return. This is particularly helpful for people investing large lump sums at once. A $20,000 investment in 800 notes, for example, can take weeks to fully invest if even a simple filter is used. Using LendingRobot, that time could be cut in half.
#3. Smart algorithm investing
The centerpiece of LendingRobot’s entire operation is its algorithm, the math it uses to choose which notes to invest in. Often investors have to choose between hundreds or thousands of available loans at Lending Club. Which are the best?
LendingRobot makes the process easier by using machine-learning to calculate which notes are more likely to perform better than others. The moment new loans are added to the platforms, the algorithm analyzes the variables of these loans and only invests in the best ones. The entire process, again, takes a split second.
As covered in part 1, algorithm investing has two major benefits:
- Increased returns – algorithm investing can potentially give you a higher return than simply choosing the loans yourself at random. They were written to beat the index.
- Protection – algorithms do not invest in below-quality loans. If Lending Club or Prosper ever lowers the standards they use to approve borrowers and adds a bunch of junk loans to their platforms, average investors would likely grab these loans without knowing the difference. But algorithm investors would not invest at all. Their cash would remain protected.
#4. Account liquidation for Lending Club
Automated investing is great, but it isn’t all that groundbreaking. In a sense, neither is algorithm investing. However, LendingRobot is the first service nationwide that gives investors the ability to quickly liquidate their account. In the language of the industry, LendingRobot is on the forefront of bringing liquidity to this somewhat illiquid investment.
What does this mean for you? It means you can have LendingRobot post all your notes for sale on Folio, Lending Club’s secondary market. LendingRobot will then slowly lower their price point over five days until they’re all sold. You could have your entire $100,000 investment in cash within a week and potentially earn a premium on the sale! This is a tremendous breakthrough in this investment.
#5. Additional lending functions
On top of these four benefits, there are a number of other features that may appeal to more experienced investors, though newer investors will probably skip these.
For example, their advanced investing tool allows you to set up multiple fine-tuned filters, much better than Lending Club’s automated tool that can only use one at a time. And when you create these filters, the robot will automatically calculate an expected return and estimate how many loans will match this filter per week.
You can even set LendingRobot to purchase notes on the Folio secondary market at Lending Club. So if some investor is trying to liquidate their account, and offers their loans on Folio at a ridiculous discount, you can automatically snag them up.
Remember, investors across the country often have no clue how to price their notes for sale, so you could earn a great return if you can figure out a strategy that works.
The Drawbacks to LendingRobot
While all this improved usability is wonderful, there are a few drawbacks to using their service. First, LendingRobot is not free. They charge account holders a fee equal to 0.45% of their managed account value (notes invested through LendingRobot), so investors who are trying to limit fees might want to stick with the free tools at Lending Club and Prosper. That said, many investors feel this small cost is worth it, made up for the increased return, liquidity, and extra features. Also, accounts below $5,000 are completely free.
Secondly, the yield-benefits of algorithms within peer to peer lending seem a bit loose to me. I do believe that using them is better than using nothing at all, and I plan to switch over to it for my personal investments by the end of the year. However, I have yet to see much hard proof that algorithm investing actually increases returns, that they can achieve alpha (Investopedia) for investors.
A final issue is that Folio buying and selling (thus, liquidating your account) is only available for Lending Club. LendingRobot is in talks with Prosper to add this functionality in the future, but for now the feature is only available for one of the platforms. Also, liquidating your Lending Club account into cash is still a bit complicated, as it requires setting correct note premiums and discounts that new investors may not yet understand. This should change though, as LendingRobot does plan to offer a fully automated “Cash Out” button this fall.
The Death of Filtering, the Rise of the Robots
Perhaps the most intriguing aspect of peer to peer lending is how Lending Club and Prosper make their loan data freely available for public scrutiny. This open data is typically split into two major groups: (subset #1) the borrower attributes and (subset #2) the loan performance data. Not only do we have info on these borrowers (past delinquencies, employment status, etc) but we also get to see how the loans perform over time (number of payments, default rates, etc).
In my view, this value of transparency is what has given peer to peer lending its darling-status within the eyes of the personal investing world. Not only does the open data allow investors to understand this investment and feel safe about getting involved, but it also encourages them to try and increase returns by backtesting the loan performance (subset #2) with different cross-sections of the borrower data (subset #1). For example, filtering for borrowers who haven’t applied for a loan in the past six months (zero credit inquiries) has historically given investors a higher than average return.
However, starting in 2013 we saw Lending Club and Prosper greatly improve the integrity of their loans, and these simple filters began to stop working. Today in 2015 a few major filters still seem to boost ROI (see here), but overall the option for investors to increase returns with filters is pretty much over.
In the place of filtering we have intelligent services like LendingRobot.
In the place of filtering we have intelligent services like LendingRobot. And while some investors may mourn the loss of self-direction that simple filtering gave us, I am glad for this change. While perhaps more complicated overall, algorithms offer us a more solid and consistent way to have a positive experience, a change this investment needs as it matures into a national practice over the coming decade.