Debt Based Alternative Investment
for Wealth Management Firms
by Gustavo Leal
Alternative Debt Landscape
Technological innovation and disintermediation of the banking industry have created a nurturing environment for the rise of several high-profile Non-Banking Financial Institutions (NBFIs). NBFIs rely on on-line channels, artificial intelligence, and an end to end automation to serve people and businesses otherwise underserved by the banks with products like consumer loans, business loans, student loans, auto finance, mortgage loans, invoice financing, agricultural loans.
NBFIs can be divided into two groups, crowdlending (or Peer-to-Peer / P2P lending) marketplaces and balance sheet lenders. In 2018, balance sheet lending NBFIs reported an outstanding portfolio of US$ 3.6 trillion (CAGR 2012-2018 of 4%), 7 times as much as crowdlending NBFIs with US$ 0.5 trillion (CAGR 2013-2018 of 110%). In crowdlending / P2P lending, the NBFIs are merely connecting lenders (investors) and the borrowers, without bearing the risk of performance of the loans originated in the platform. The balance sheet lending NBFIs keep the loans issued to the borrowers on their portfolio, hence the name.
The majority of NBFIs are dealing with consumer and business lending, which together represents more than 90% of the market volume. Other niches include property lending, real state crowdfunding and equity-based crowdfunding. The crucial difference between an NBFI and a bank is that the former does not hold a full banking license and therefore cannot accept deposits. Given this limitation, NBFIs rely either on equity or bond funding to cover cash flow needs of their growing loan portfolios.
Alternative Debt As An Asset Class
Investing in balance sheet NBFIs enhances investment portfolio diversification without sacrificing expected rates of return (ERR). When comparing different asset classes, NBFI debt presented the second-highest expected returns of 10.6% and the smallest volatility, resulting in the highest sharpe ratio.
How to access Alternative Debt
Most NBFIs are privately owned and their equity is hardly easily accessible. Until recently the NBFI’s bonds were also available only to institutional investors or selected High-net-worth individuals (HNWI). Therefore, most conventional channels for non-institutional investors to participate in this market are P2P marketplaces, P2P aggregators and less commonly through Specialized funds.
Hence, most options to invest in alternative debt rely on P2P marketplaces although they are limited and often problematic.
a) Moral Hazard stemming from non-aligned interests between investors and the platforms operators
b) Asymmetric information since the P2P marketplaces hold strong information advantage over investors
c) Concetrated credit risk as investors allocate their funds into individual loans on sale
d) Lack of liquidity due to a shallow secondary market and draining liquidity in the times of crisis.
Kilde Overcomes shortcomings of the P2P platforms
We have decided to fix the issues from P2P marketplaces with KILDE, a global lending marketplace that connects balance sheet NBFIs and investors. KILDE is one of the few platforms that allows non-institutional (accredited investor) investors to access NBFIs debt. With KILDE, investors take advantage to diversify their investments into retail and SME loan products without a risk exposure to individual loans. The credit risk is spread among a handful of balance sheet NBFIs.