Sunday 14 October 2018

P2P Investment Strategy Part 1 – Diversification

I picked TruePillars as my initial lending platform specifically for the ability to choose individual loans to allow for full control over my portfolio.  This will allow me to build up my portfolio in a manner that I am comfortable with.  The first strategic goal for me is to develop diversification.  Peer to peer lending is diversification from other investments such as shares or property, however within every investment class there is an element of diversification to minimise risk.  In the case of peer to peer lending, diversification is ensuring your money is spread across as many different loans as possible.  By doing this you reduce your exposure to any single loan defaulting and still make a profit from the remaining portfolio of loan investments.  While diversification on the surface may seem fairly straight forward, it is important to have a plan as to what diversification looks like to you and how you intent to achieve it. 

There are two main elements to my diversification strategy:
  1. The number of loans and the collective percentage of my investment in each (exposure)
  2. The range of industries I’m lending too

Exposure of your loans

My current focus is a short term target around the quantity of loans I’m involved in.  Presently I’m aiming to achieve no loan at greater than 5% of my total loan portfolio value which I plan to accomplish over the first few months of investing.  To put this in perspective it means I need to acquire a minimum of 20 loans of equal value to make up my portfolio.  There are several important reasons why you should think about and set you own exposure target.  The main reasons are
  • Helps define your maximum investment per loan
  • Helps define your total minimum investment required
  • Helps keep your total portfolio profitable in the event of a single loan default

I’ll use the TruePillars site to give an example of what your portfolio would look like considering the above.  TruePillars have a $50 minimum investment into new loans.  If we set this as our maximum investment per loan, we will be able to calculate how much money we need to invest across multiple loans to achieve the target diversification.  Put simply you need to invest $50 x 20 loans = $1,000.  Sticking to the maximum individual loan amount while increasing the number of loans post your target will further lower your individual exposure.  I’ve set my target per loan and I don’t plan to exceed it regardless of the size of my portfolio.  If you are concerned about any one investment, you can calculate the individual loan exposure by taking the value of the loan and dividing it by the total value of all loan investments.

What I’ve experienced is it was not possible to meet my diversification target when I first started investing.  This was because there was insufficient new and existing loans available for purchase and it’s something you may experience too when first starting out.  To overcome this, my plan is to regularly add capital and buying new and existing loans as they become available.  While I’m not quite at my diversification target yet, I’m well on my way with what I’ve found to be a fairly active new and existing loans market.

Minimising individual loan exposure is important when it comes to overall portfolio performance.  Ultimately you want the overall returns to exceed any losses you may incur from a loan default.  Given TruePillars performance is indicated at 9% returns and has a current overall performance of 12%, a 5% exposure means even if one of my loans defaults, the most at risk is 5%.  This potential loss should thus be covered by the overall return of the rest of the portfolio.  As my portfolio grows the impact of a default reduces, providing I stick to my maximum individual loan investment limits.  It also ensures that my portfolio remains more profitable overall.

Diversifying the industries into which your loans go

My secondary strategy for diversification is to deliberately consider the industry sectors of the loans I am investing in.  I’ve not currently tracked how this has progressed to date, however I’ve managed to achieve reasonable diversification from automotive to food services, from recreational sports to building services and a few other sectors in between.  Having exposure to different industries means you should have less risk in the event of market disruption to a particular industry that may affect their ability to pay back a loan.

Ultimately the goal of diversification is to ensure all your eggs are not in the one basket, quantitatively in terms of the amount of your loans, and qualitatively in the types of loans you’re contributing to.

Now that we have covered the basics of my diversification strategy my next blog will talk about how I’ve selected the loans I’ve invested in and what I look for when I assess whether to invest or not.   This journey is only beginning and I’m sure the path will change as I adapt and refine the strategy as my lending experience grows.   Interested to hear other people’s strategies and approaches as collectively we can learn, grow and succeed together.

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