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Does Digital Lending Add Value to an Investor’s Asset Mix?

Does digital lending add value to an investor’s asset mix?

Digital lending is a hot topic. And as we commented in our last post, even a global pandemic has not mitigated the segment’s momentum. Quite the opposite in fact. However, further growth will only be sustained if institutional investors start entering the stage to fuel the supply side with bigger cheque sizes – and if some key questions about digital loan performance are addressed.

In this post, we take a closer look at why digital lending and private debt receive so much attention and whether it might be a good idea for institutional investors to have a closer look at this space (Spoiler alert: yes, it is).


In a nutshell, we modeled the investment opportunity set of traditional asset classes available to a European institutional investor and compared the results with an enhanced set that includes digital lending.


Market Data and A Lot of Number Crunching 

For our benchmark opportunity set, we created 1 million different portfolio allocations with the monthly return series of indices representing the following asset classes: equity, real estate, corporate bonds, sovereign bonds, and private equity (1). To take a more meaningful perspective across the last decade, we considered the historical return observations from January 2011 until June 2020.

Since the digital lending market is still relatively young and not standardized, a benchmark index with a long data history is unfortunately not readily available (Spoiler alert #2: we are working on it). For now,  we turned to academic research and number crunching. Following the methodology in “The Components of Private Debt Performance” proposed by Giuzio et. al. in 2018 in the Journal of Alternative Investments, we approximated the returns in digital loans on the basis of European bank lending rates. (We will shed more light on the method behind our madness in another post).

(1) For equity, we used the MSCI Europe, an index that comprises 435 European Corporates and captures roughly 85% of the market cap of European Industrial Nations. For Real Estate we looked at the MSCI Europe Real Estate Index, a free float-adjusted market capitalization index that consists of large and mid-cap stocks in the real estate sector across 15 Developed Markets (DM). Furthermore, Euro-denominated, investment-grade corporate bonds, and sovereign bonds were proxied using the iBoxx EUR Non-Financial and iBoxx EUR Eurozone bond indices. Private Equity is represented by the STOXX Europe Private Equity 20 Index, which is designed to measure the performance of the 20 largest private equity companies in Europe.

Visualizing Our Results: Digital Lending Is an Interesting Piece in the Asset Allocation Puzzle

To build the opportunity sets, we created all allocations using no-leverage assumptions & no-short-selling constraints. We also constructed the respective efficient frontiers and color-coded the Sharpe Ratio of each individual portfolio for better comparability. The results we get when constructing portfolios with varying allocations using the traditional asset classes are displayed on the left in Figure 1. On the right-hand side, digital loans are added to the mix.

Figure 1: Results with traditional assets vs. Results when adding Digital Loans

The color scale on the far right indicates the value of the Sharpe Ratios (red = high, blue = low). The results show that adding digital loans to a traditional asset mix can significantly improve the investment opportunity set as evidenced by the higher Sharpe ratios of portfolios that can be constructed. For simplicity, the risk-free rate is set to 0 in all our calculations. The results indicate that adding digital loans can help diversify an investor’s traditional asset mix,  and improve investment performance. Part of the result can be explained by the low correlation of digital lending to traditional asset classes.

For a better display, we also contrast the different opportunity sets without the noise from the individual portfolios. You can see our calculated efficient frontier in Figure 2. The direct comparison shows that the efficient frontier including digital loans clearly dominates the attainable results without digital lending.

Figure 2: Efficient frontier of Traditional Asset Mix vs. Adding Digital Loans

Our findings show that adding digital loans to a portfolio could be an interesting new way for investors looking to diversify their portfolio holdings, particularly given the backdrop of a low yield environment.

 

Exaloan is working on standardizing and automating digital loan investments for institutional clients across the globe. We are convinced that digital lending is a highly interesting and impactful emerging new asset class and with studies like these we hope to invite more interested parties to our dialogue.

Leave a comment or a question, we appreciate the input.

 

As mentioned, we will dive deeper into the return construction for digital loans in one of our next posts. Follow us to stay up to date. 

If you would like to read the full research paper, or find out more about how we enable institutional investors to tap into the digital lending market, click the button on the right!

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The effect of Covid-19 on the digital lending market

The effect of Covid-19 on the digital lending market

Covid-19 crisis has increased the need for digital lending platforms and their products more than ever. Yet, most platforms are facing a major lack of funding.

The Covid-19 pandemic and its subsequent lockdowns have confronted many people with the challenges of raising funds – fast, and without personal contact. While optimally positioned to supply financing in the form of digital credit, the pandemic has had adverse effects on alternative lending platforms.


In Indonesia, one of the largest markets for digital lending with 7.4bn USD in distributed loans as of June 2020, credit demand is surging – with the regulatory authority reporting a 166% year on year increase in requested loan volume. Investment appetite registered by Singapore-based SME lending platform Validus is now surging above pre-crisis level as investors realize the benefits of digital lending, including its low correlation to public markets in times of economic uncertainty. Digital lending platforms across the globe have alleviated credit financing for businesses and SMEs to help secure the liquidity needed to mitigate the effects of the sudden economic downturn.


Simultaneously, balancing demand with funding supply imposes a challenge to many bilateral marketplace modelsLending Club one of the largest digital lenders globally, experienced a 90% yoy drop in loan origination volumes in Q2 2020. The pandemic also threw monthly loan origination levels in April and May 2020 of Mintos, the largest loan origination aggregator, back to 2017-levels.


The Frankfurt-based SME credit platform Creditshelf was highly affected by the pandemic, leading to a decrease in the loan volume by 31% in the first quarter of 2020 compared to the same quarter of the previous year and almost by 70% from the last quarter of 2019. Even though the requested credit volume rose by 60%, only 2.3% of the loans could be granted. Meanwhile, loans distributed by the Finnish Fellow Finance platform have been providing positive investment returns, which has even improved from the same period last year. They facilitated 10.7m USD of loans in June and the number of investors has been rising since the beginning of 2020.


Similarly to loan volumes and investment returns, default rates were also adversely affected by the pandemic, increasing both in Europe and Southeast Asia. Among European digital lending platforms, default rates vary between 3%-6%, where the highest ones were captured in the past two months. Meanwhile, in Southeast Asia, they slightly increased in comparison with the last quarter of 2019 ranging between 13%-16% and reached their peak in March.


While the pandemic will undoubtedly drive out unsustainable lending businesses in the long run, the necessity to further the digital lending market is obvious. Direct lending has long offered attractive risk-adjusted returns compared to traditional investments, and due to its low correlation to the public bond and equity makers, now might be an ideal time to begin exploring how to invest in it at a scale – and help businesses continue distributing necessary funds to their borrowers.

Learn more about how we can provide you with one interface to the source, score, and ultimately fund millions of individual loans across markets.

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First anniversary of Exaloan

First anniversary of Exaloan

Dear  Exaloan  Community,
Today  marks a very important milestone for our team as we celebrate  Exaloan’s  first anniversary.  In turbulent times, we are happy to take a moment, look back and share our experience and thoughts throughout this journey that got us where we are today.

Exaloan is a Frankfurt-based Fintech that specializes in developing machine learning tools for predictive analytics in digital loans. We provide institutional investors with cutting-edge technology to connect and invest in digital loans on a global scale with full automation and standardization across the market, according to their own risk preferences.

It amazes us to see, how what started as an idea has now become a reality. Over the course of just one year, we managed to expand from humble beginnings to our current hardworking team, whose ongoing quest for insights and tireless commitment we appreciate deeply. It never fails to impress us to see how the ideas we drafted on paper at the start of the company now became a product and a working business model. A crucial step in our journey is to surround ourselves with a network of trustworthy partners sharing our vision, and we are very grateful to have PWC on board. Their valued expertise has helped us set up and streamline our business and processes. Through their contributions, we can deliver on our promise of facilitating the deployment of compliant capital in the digital lending market.

In February, we have also kicked off our global expansion with the acceptance and incorporation into the German Accelerator Program South East Asia, an initiative of the German Ministry of Economics and Technology. Their ongoing support is invaluable to us in strengthening our footprint in one of the most vibrant regions in the world. With offices in both Frankfurt and Singapore fully up and running, we feel well prepared to tackle any challenges that arise in the future.

The digital lending market is projected to continue to accelerate due to rising technology penetration which will foster the digitization of lending markets and financial service institutions. More and increasingly better data will become available, which will help both borrowers and lenders find together on fairer terms. These factors combined with the services that we offer in the digital lending market continue to drive our business model forward.

In conclusion, we are grateful and proud of how far we’ve come and eager to continue working on our vision to close the global funding gap. Enthusiasm and anticipation are building around new opportunities and we look forward to another successful year and all the milestones and achievements to come.


Thank you to everyone who is accompanying our journey!

All the best and take care,
Exaloan

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