Executive Summary
In today’s low-interest-rate environment, the pressure is on for advisors to add value when it comes to fixed income allocations. Yet unfortunately, some of the most appealing segments of the fixed income markets to generate higher yields – such as peer-to-peer (P2P) investing – have little or no means to fit into the typical financial advisor investment platform.
But that may soon change, as peer-to-peer analytics and management solution NSR Invest prepares to launch the first integration of P2P investment platform Lending Club to ‘traditional’ advisor portfolio analytics solution Orion Advisor Services. The ultimate goal – to make it feasible for financial advisors to manage client investments in P2P loans, including allocating capital into individual loans (in a diversified manner), managing cash flows in and out of P2P investment accounts, and facilitating consolidated performance reporting of P2P investing and the client’s other portfolio investments. All done in a manner that advisors can even bill for their services.
Of course, the caveat is that peer-to-peer investing still has significant risks to accompany the higher yields it offers, from a material risk of default (which can only be partially diversified away) to significant illiquidity if clients unexpectedly need to sell their allocations. Nonetheless, the relatively new sub-asset-class within the fixed income environment remains appealing for yield-starved clients, and NSR Invest’s technology may finally make it feasible for, at least, independent RIAs to begin to allocate client dollars to P2P investment opportunities!
The Problem With Peer-To-Peer Investing (For Advisors)
For most financial advisors, investing client assets means putting them into investment vehicles like mutual funds and ETFs that can be traded on a custodial platform, purchasing market-traded securities like stocks or bonds directly, or for those with a broker-dealer relationship “selling” other alternative forms of registered securities (e.g., non-traded REITs). Which means investments that aren’t available to advisors under traditional broker-dealer or custodian relationships typically aren’t made available to their clients, either.
Accordingly, when it comes to investment opportunities like peer-to-peer lending (or rather, peer-to-peer investing as a prospective lender), advisors have had little if any exposure to the marketplace, despite its arguably rather appealing fixed-income returns (albeit with significantly more risk and potential volatility along the way).
Technically, an advisor has long been able to encourage clients to open an account directly with peer-to-peer investing platforms like Prosper or Lending Club, but helping clients invest there was/is tedious at best. The importance of extensive diversification (given that even the highest quality individual loans still have a material risk of default) is crucial, but manually allocating investments across a wide range of peer-to-peer loans is time consuming. Automated tools from the platforms (e.g., Lending Club's Automate Investing, and Prosper's Automated Quick Investment [AQI] solution) that help facilitate the allocation of capital across a wide range of peer-to-peer loans could help, but the relatively simple automation algorithms may not be best for deploying client assets. Of course, just having client login name and password credentials to do this on their behalf could trigger the SEC custody rule for advisors as well.
Even when these dynamics could be navigated, it has still been difficult for advisors to help manage the overall process holistically for clients. Client account balances at peer-to-peer lending platforms generally don’t aggregate into traditional advisor portfolio accounting and reporting tools, making it difficult for advisors to actually “manage” and report on the assets as part of the total portfolio. And if it’s impossible to effectively report on the assets, it’s also nearly impossible to capture the information necessary to bill on them, even if the advisor is helping to manage them holistically!
In other words, even if advisors wanted to allocate client assets towards peer-to-peer investing strategies to pursue better yields than other fixed income alternatives, the available technology solutions have made it impossible to do so. But that is now about to change.
NSR Invest Rolls Out Platform For Financial Advisors
To plug the advisor technology gap when it comes to peer-to-peer investing, a technology solution called NSR Invest is building the first integrations to connect peer-to-peer lending platforms like Prosper and Lending Club directly into advisor technology tools.
For those who aren’t familiar, NSR Invest was actually created earlier this year from the merger of two separate platforms – a site called Nickel SteamRoller (now NSR Platform) that was one of the first online resources to analyze the loan history of Lending Club and later Prosper, and a second site called Lend Academy Investments that packaged together some of the early versions of separately managed accounts and pooled funds for investing in peer-to-peer loans. Under the new NSR Invest, the goal is to offer a wider range of full-service managed accounts for peer-to-peer investors, expand the pooled investment funds for accredited investors allocating dollars into peer-to-peer loans, and build out an order management and reporting platform for institutional investors.
It’s the latter development in particular that has relevance for advisors. As a part of its institutional platform development, NSR Invest is building its first integration directly into advisor portfolio accounting software tools, starting with Orion Advisor Services.
Once the integration is completed (anticipated rollout in December), Orion will be able to pull in transaction-level peer-to-peer loan investment data directly into the software from a client’s Lending Club account (a connection to Prosper accounts is planned for a future release). In turn, this finally makes it feasible to include such “P2P” investments as a part of not only the client’s consolidated balance sheet but also to calculate aggregate performance of the entire portfolio (including peer-to-peer loans). And notably, also makes it possible for advisors to bill for their advisory support related to the client’s fixed income allocation to P2P investments!
Using The NSRInvest Platform To Manage P2P Investing Strategies
Notably, the integrations between NSR Invest and Orion are expected to allow not only for the reporting on the client’s peer-to-peer investment holdings, but also the ability to outright manage those investments through NSR Platform.
Creating Custom P2P Algorithmic Investment Strategies
As noted earlier, Nickel Steamroller originated as a platform that could pull in historical loan performance data for Lending Club (and later Prosper), to run historical analyses of performance with any number of filters (e.g., to review the results of all loans of investment grade B or better, that were income verified, with a 5-year term, created in 2010 or 2011, and were used for the purpose for debt consolidation). This made it feasible to backtest P2P investing strategies based on historical data.
Accordingly, the next layer of the NSR Invest platform is for advisors to then use that data to create their own P2P loan allocation strategies. For instance, if the advisor prefers to only fund loans of A-quality of better, with a 3-year term, being used for debt consolidation by those who are income-verified and who have at least 5 years of employment history, while allocating no more than $200 into any particular loan, NSR Invest can now facilitate the process and with its own integrations directly to Lending Club (and soon, Prosper as well) to actually invest the dollars.
Thus, for instance, if the advisor wishes to allocate $40,000 of the client’s assets into 200 different loans that meet the criteria, the funds are simply transferred to Lending Club – which NSR Invest can help facilitate directly from the client’s authorized bank account – and then allocated into the desired loans for investment as new borrowers who fit the criteria come to the platform to request funding (which is the whole function of peer-to-peer lending platforms in the first place – to match borrowers to investors).
Alternatively, advisors can also use NSR Invest’s own P2P investment strategies – aptly dubbed “conservative, balanced, and assertive” – which currently target net returns (after default/write-downs) of 5%, 7%, and 10%, respectively. By following this path, client assets are allocated into P2P loans based on the NSR’s own investment strategies and expertise, rather than the advisor being required to determine the loan implementation strategy.
Costs For Using NSR Invest To Manage P2P Loans
For advisors who want to use the NSR Invest platform, the cost is 45bps, which is billed quarterly in arrears based on the client’s average daily balance in the P2P investment account for the preceding quarter.
Notably, the arrangement is formally structured with NSR Invest as a sub-advisor to the investment adviser’s own client relationship, which technically means the advisor is responsible for collecting the investment management fee and remitting it to NSR Invest. In practice, this means the advisor can either bill the client’s other investment accounts and remit the amount to NSR Invest, or it can be swept directly from P2P investment payouts of principal and interest as they occur from the P2P platform investment account (and NSR Invest has been working on additional enhancements to allow NSR fees for supporting the P2P investing process to be swept directly from the P2P account at Lending Club).
For advisors who want to rely upon and outsource to NSR Invest for its proprietary P2P investment strategies, rather than create their own P2P allocation algorithms as the advisor, the fee is increased from 45bps to 60bps. In this context, the advisor still determines how much of the client’s cash/assets to deploy to the P2P platform and facilitates the transfer, and then effectively hires NSR Invest as the subadvisor (and the client will literally sign a sub-advisor agreement with NSR) to implement the process of allocating dollars into P2P loans. So ultimately, the advisor gets to decide whether to either use the advisor’s P2P investing algorithm for 45bps, or letting NSR implement their own for 60bps.
Ostensibly, the advisor would still charge his/her own fee for making the decision about whether and how much to allocate to the P2P investment strategy, and then would ultimately pass through the NSR investment costs, in a similar manner to any other outsourced/third-party investment manager or subadvisor (where the advisor charges a wrap fee, and then the client pays the underlying mutual fund manager’s expense ratio or a separately managed account fee). Of course, it’s also worth noting that with the significantly higher yield in P2P loans compared to most other fixed income investments, there may be less fee pressure on the arrangement.
Automating Cash Movements Between Brokerage And P2P Platforms
Beyond using the NSR Invest platform to manage clients deploying their cash in a P2P investment account into the underlying peer-to-peer loans, NSR’s next development effort is to more fully automate the cash movements between a client’s other investment accounts and the available Lending Club and Prosper P2P platforms. This would effectively allow advisors to more dynamically “rebalance” between P2P accounts and brokerage accounts, and thus adjust allocations in/out of P2P investments over time.
In fact, while the original NSR Invest process only automated pulling client cash from a bank account with ACH capabilities to facilitate the transfer (which is not how most brokerage accounts are structured), their latest iteration now permits transfers to occur directly from brokerage accounts to a related P2P account. While the connections still have to be authorized by clients to permit transfers initially (a manual step of the set-up process), this should further facilitate the process of managing client households across "traditional" brokerage and P2P accounts (at least to/from Lending Club, which can facilitate this thanks to their more robust APIs than competing provider Prosper).
On the other hand, it appears that while P2P investing accounts can handle retirement assets – and in point of fact, the high yield of P2P loans make them an especially appealing fixed income investment to hold within a tax-deferred retirement account – at this point the process of transferring money from one retirement account (e.g., at an IRA custodian) to another retirement account (at the P2P platform) requires paperwork with client signatures. Ultimately, NSR Invest hopes to help automate more of these cash transfers as well. Nonetheless, NSR Invest can still handle the performance reporting and deploying client cash into P2P loans, once the funds have actually be transferred into the proper IRA.
Will NSR Invest Open A New P2P Alternative Fixed Income Asset Class For Advisors?
Today’s low return environment has put increased pressure on advisors to justify their investment management fees, especially for low-yield fixed income investments. This has spawned everything from controversial hybridized fee structures (with ‘discounted’ investment management fees for the cash and fixed income portion of the portfolio compared to the equity portion), to the rapid growth of many “alternative” asset classes serving as fixed income substitutes as clients demand and stretch for better returns.
In this context, the opportunity for advisors to help clients invest in P2P loans represents an opportunity to add value and diversify into a new subset of the fixed income category itself, one with far more appealing yields and the potential for higher total returns. Of course, the caveat to investing in peer-to-peer loans is that even the highest quality loans still have a material default risk, and the default rate will only rise further if/when the next recession occurs (P2P loans from the 2008-2009 period barely ended out with positive total returns!). In addition, the loans are generally illiquid and difficult to sell if clients need to raise cash, though fortunately their relatively short 3-5 year maturities and the fact that only a limited portion of fixed income assets would be allocated to the asset class helps to mitigate the impact. And the emerging rise of a secondary market for P2P loans, currently through a FolioFN note platform platform, also help to provide at least some liquidity (though realistically, in a significant market sell-off, the available bids for P2P loans in the Folio marketplace may not be at a price a seller wants to accept, as the market is still very thinly traded!).
Notably, the starting point for NSR Invest is “just” to integrate with the Orion Advisor Services platform – due out sometime in December – so advisors not using Orion will have to wait a bit longer until NSR expands its integrations to other portfolio accounting solutions. Or alternatively, advisors could use the NSR Invest platform directly to manage P2P investing for clients (or have NSR Invest manage it using their proprietary strategies), but as an externally managed account that isn’t reported alongside the client’s other investments.
On the plus side, since the solution is being driven through the portfolio accounting software, NSR Invest will be “custodian agnostic”, so it won’t matter whether the RIA custodies the rest of a client’s assets at Schwab, Fidelity, TD Ameritrade, or elsewhere. (Though ultimately the funds being invested in P2P loans will leave the custodian to go to the P2P platform anyway, and the process of trying to automate cash transfers to fund P2P platform accounts may vary depending on the custodian.) Advisors will “just” need to enroll in the NSR Invest platform, activate the Orion integration, have clients sign a sub-advisor agreement with NSR Invest, and update their Form ADV to reflect the sub-advisor relationship.
On the other hand, the fact that NSR Invest is partnering with advisors through independent portfolio accounting software solutions also highlights the fact that, at least for the time being, NSR Invest’s offering will only be available to independent RIAs. Advisors who work at a broker-dealer would need NSR to go through the broker-dealer’s application/approval process to become an outside manager, which NSR Invest isn’t pursuing at this time (and even then, Orion is generally not used by captive advisors at a broker-dealer). Whether NSR Invest ultimately expands to work via brokers with at least the independent broker-dealers remains to be seen; for the time being, they seem to be focused on working with RIAs first, who have an easier process to integrate and work with NSR directly.
Nonetheless, given the ongoing growth of independent RIAs, the new availability of the NSR Invest platform creates the potential of opening up a new fixed income asset class to at least a subset of advisors, in a manner that has some additional cost but seem to be much less expensive than most of the third-party managers emerging to offer peer-to-peer investment solutions for clients.
Of course, it still remains to be seen whether the NSR Invest solution is able to execute P2P investing for advisors and their clients as efficiently as they hope – while NSR Invest won the “Most Promising Prototype” award at the Fuse Hackathon earlier this year, the integrations are just now being completed and are slated for release in December. But to say the least, for advisors who are looking to add a little more variety to client fixed income allocations, and the potential for some higher returns (albeit with greater risks!), NSR Invest should be worth a look soon.
So what do you think? Have you ever looked into "marketplace lending" P2P investing solutions, either for yourself or for your clients? Would you be interested in using a platform like NSR Invest as a means to add an allocation to this type of fixed income asset class for client portfolios?
Thanks for another great article. Any thoughts about states that don’t currently allow P2P lending such as Maryland. Will this new service be a work around?
Debbie,
Ultimately, the client still opens/own a P2P account (in NSR’s case, with Lending Club) in their own name. So if the client’s home state doesn’t allow P2P investing accounts at all, I don’t see NSR Invest as a workaround. Though realistically, if/when/as this continues to grow as an investing asset class, I’m betting the state will eventually adjust and permit the accounts (as they’re already permissible in almost all states now)…
– Michael
Correct. Lending Club has added either 9 or 11 states this year alone… I believe it’s only a matter of time before all states agree that investing in SEC-registered securities via a web platform is a reasonable investment activity.
Until that time you can direct accredited investors to p2p lending *funds*. There are many private funds out there. You’ll find that these typically have all the characteristics of other GP/LP funds, including management fees, investment minimums, lockups, etc. Feel free to be in touch, and I’ll give you some names of funds that may be of interest. (Full disclosure: I manage the Lend Academy P2P Fund, LP, and advise several others.)
With the default rates we’re talking about here and the lack of E&O coverage offered to this asset class, only advisors who also enjoy Russian Roulette advisors will participate at this stage. I know for a fact that P2P/Marketplace lending is excluded from coverage on my Calsurance E&O policy (they deem it a ‘promissory note’). Until this issue is resolved, in addition to figuring out how advisors actually get paid, avoid custody, can report/rebalance on a broader range of platforms, and can provide a robust secondary market, there is a gaping opportunity for someone to come along and do this right.
Anon,
Well, NSR Invest is trying to solve many of those issues (support advisors getting paid, avoid custody, facilitate reporting and rebalancing, etc.). Though obviously they can’t do anything with the E&O coverage.
I’ll explore the E&O angle further. I’m honestly not certain how widespread it is for advisor E&O policies to have exclusions for P2P marketplace lending, and/or how they even define it (direct P2P, vs third-party-managed P2P, vs a mutual fund that happens to own P2P, etc.)…
– Michael
Anon:
I’m glad you bring this up, because advisors need to understand the challenges they would encounter by trying to access p2p lending for their clients without the help of a company like NSR Invest. All of the issues you bring up (save the bit about insurance, which we’ve talked about in the past) are genuine concerns for our clients, and it’s why they use NSR Invest. That’s really the whole point.
Regarding E&O, our insurer (rated A+ by A.M. Best) is one of several that bid on our account, and offered very reasonable terms. And all we do is p2p investing. So far, we’ve had hundreds of conversations with FAs and only one has found concerns with their E&O coverage. I think it’s a red herring, and it’s caused by a communication breakdown. These “Borrower Payment Dependent Notes” are registered with the SEC and backed by a loan issued by a proper bank. I’d be happy to speak with your underwriter directly, as you know, to help them better understand these investment securities.
As for your other concerns, I think Mr Kitces did a fine job of explaining it. (1) NSR reports back to your PMS so that the assets are no longer “held away”, and you can get paid on them. (2) NSR reports back to your PMS so you can see p2p performance alongside your other assets. (3) NSR avoids the custody problem by keeping the accounts at arms’ length and trading via API. (4) Secondary market trading is about to get a boost: Version 3.0 of our platform will support API-based selling… and we are scheduled to launch 3.0 before the end of the year!
I hope you’ll be back in touch with us soon so we can solve your specific E&O issue together.
What we are seeing is the beginning of the end for P2P lending. Really, at what point does this stop being “P2P” lending at all? With a huge influx of institutional capital, I cannot see return rates staying where they are. Institutional investing will suck all the oxygen out of these platforms for individual investors, yields across all risk categories will fall as the larger fish compete for a part of the risk pools that cannot grow as fast as the demand for yield.
Jason:
We heard no end of this argument back in 2011-2012 when the institutions started invading the space. BlackRock, Santander, Morgan Stanley and many upstart funds came roaring into p2p as soon as it hit the 5-year mark, and volumes really started to rise.
But the backlash from retail investors was strong, and the moral compass of Lending Club leadership is straight. Lending Club (and others of course, but most importantly LC) has a strong standing commitment to the retail investor. There are two key reasons for this:
1) LC was founded as a true peer-to-peer marketplace, and serving the retail investor has always been an important mission for Renaud Laplanche and his team
2) LC values a diversified investor base. They don’t want just institutions on their platform. Note that in 3q15 alone, $590 million of LC’s total $1.7 billion of originations were directed to the fractional pool. The fractional pool is where the retail investors shop for investments… and they command 35% of the marketplace! This is great news for retail investors, and for Financial Advisors.
At this point (tail end of 2015), we are hearing a lot less grumbling about institutions invading the p2p space and driving yields down. It simply hasn’t happened. In fact, I think we are approaching something of an equilibrium, where large institutions and retail investors are finding room to play alongside each other, thanks especially to the consideration and forethought of originators like Lending Club.
Bo, (and Jason) and everyone else:)
As an early adapter, investor, and lender since 2009, I can attest to the returns for an individual investor holding up pretty well, after fees, defaults, institutions coming in, etc.
Yes, LC has committed itself to always include the individual investor, which I am very happy about., and participate in, as a wide investor base is achieved thru the allocation of loans to the investor platform, which I am certain LC will continue to do so, as stated at the LendIt 2015 conference. Am looking forward to the 2016 LendIt in SF upcoming in April 11-12, which is the world’s largest on line lending event that everyone should attend to learn more about this space.
By the way, as personally am an investor in the P2P fund that NSR offers, the Lend Academy P2P Fund, one can participate in all states, regardless of their state’s approval for the individual loans to be invested in.