Monday 22 October 2018

P2P Investment Strategy Part 2 – Loan Selection

Diversification plays a large part of my investment strategy (P2P Investment strategy - Part 1) and while it is important, I believe you can further minimise the risk of loan default by selecting loans with businesses that appear to have stable fundamentals.  TruePillars offers two markets for loan investments, new business loans which are filled via the auction process and the secondary loan market where investors can sell their current loan investments to other investors.

New Loan Selection

Currently I’ve not been overly critical with reviewing and bidding in the auction process for new loans that have come onto the market.  My thought process behind this current strategy is that I believe new loans should be lower risk in the first few months / year (I’ll keep you posted on if I’m right…).  I’ve also taken this approach at this point in time to create diversification of my portfolio.  TruePillars also offers the ability for me to sell my investment to other investors if I deem it doesn’t fit my risk profile later.  Having observed a fairly active trading of existing loans, I don’t see the potential of been stuck with a loan I don’t want as a high risk at this stage.  In the future I may review this strategy and be more selective in my choices if I find I’m having to sell off too many loans.  There is a cost to sell a loan so you ultimately want to aim to hold the loan until it is paid off to maximise your returns.  

Secondary Market Loan Selection

While one could say I’ve taken a pretty lax approach to new loans, I’ve been much more selective on purchasing existing loan investments via the secondary market.  This is because I view existing loans as potentially carrying more risk.  The longer the loan has being issued, the more chance of borrower circumstances changing which may affect their ability to pay back the loan.  In assessing these loans I consider four main items which can be found on a loan information page on the TruePillars website

  1. Repayment history (Loan history tab)
  2. Loan Size / Term (Summary tab)
  3. Net Profit after Tax (Financials tab)
  4. Net Assets (Financials tab)
When it comes to the repayment history, I’ve currently don’t consider loans that have had any late payments.  The reason for this is, rightly or wrongly, I interpret late payments as potential cash flow issues which could affect future loan repayments and the ability of the company to continue to operate. 

If it passes the no late payments test, I then look at net profit after tax.  Here I’m looking for a trend of growth.  Note the most recent figures for profit may not be a full year’s figure and hence not an apples for apples comparison for the previous year’s results provided.  A quick method to assist is to divide the value by the number of months it covers over the financial year and times by 12. For example, if the latest results cover up to the end of February, then you divide by eight (July to February) and multiple by 12 to give you an indicative figure of full year results for comparison.

I then look at the net assets to see if the business the potential value to cover the loan.  If the net assets exceeds the value of the loan, there is a potential in the event of default for the outstanding loan to be recovered from the assets of the business.  Where there isn’t sufficient assets, I look at the net profits to see if there is sufficient profits to cover the full value of the loan with two to three years.  Having a healthy profit indicates to me that the business shouldn’t have any issues meeting their loan obligations.

I hope this is helpful and gives a bit of insight into how I’ve selected the loans that currently make up my TruePillars portfolio.  Interested to hear if other people have a different approach or whether they agree or disagree with my approach.  My next blog will touch on the third part of my strategy around Performance Management.

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