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Prosper Showing the Importance of Diversification

Prosper Showing the Importance of Diversification

Peter Renton·
News Roundup
··1 min read

In this blog post earlier today, Prosper laid out the case for diversification of your p2p investment among many different loans.

As long time readers will know I have been preaching about diversification now since I started blogging here. I see many investors making the big mistake of not being fully diversified, so when Prosper put out this post I immediately wanted to highlight this information.

On Prosper 100 Loans Provides Good Diversification

Prosper has taken a look at all the “seasoned loans” (loans that are at least 10 months old) issued on their platform from July 2009 – January 2011. Prosper looked at the accounts of the 14,140 investors who have invested in some of the 7,700 loans originated during this time period. They excluded notes that were bought and sold on FolioFn, the Prosper trading platform and created the graph and table below showing the impact of loan diversification.

ROI on Prosper p2p loans

What they found is that every investor who has invested in at least 100 notes during this time period has made money. And as you can see in the chart the more loans an investor has the higher the annualized return on average. So, for investors with at least 400 seasoned notes they are earning an average return, according to Prosper, of 11.67%, pretty much a full percentage point higher than the 10.69% Prosper states is the average return for all investors.

Most P2P Investors Have Less Than 100 Notes

The other piece that I found very interesting about this post is that 90% of investors on Prosper have less than 100 notes. And it is these people that have the largest variance in returns – ranging from -100% to 42.81%. I imagine the people (or person) that lost 100% of their portfolio invested in just one loan that subsequently defaulted immediately. And to earn 42.81% that investor took advantage of some of Prosper’s bonuses – with a maximum interest rate of 32% there is no way to earn more than that without bonuses.

Whether or not you think these returns are sustainable, I think we can all agree on one thing. If you have less than 100 notes in your portfolio, you are not well diversified and you are relying on luck for a great return.

What do others think? Please leave a comment below and share your thoughts.

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Dan B
Dan B
Dec. 12, 2011 6:44 pm

“Seasoned loans”, is a term that Prosper invented a couple of months ago for reasons that I’ve already speculated on at another blog. I don’t see the point of rehashing that negativity here & I will leave it to someone else to argue the level of seasoning that Prosper tends to use in reporting their results.

However,…………why does the text of the above information refer to seasoned loans issued through Jan. 2011 but the graph, on the other hand shows loans through Oct 2011………….when Prosper defines that a seasoned loan has to be 10 months old or more? So which one is it? What is this graph suppose to be showing?

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Roy S
Roy S
Dec. 12, 2011 8:00 pm

I haven’t taken an in-depth look into this yet on Prosper’s blog, but I did a quick check to get your answer, Dan. The calculations were made on Nov. 4. So you take all the loans that are 10+ months old at the end of October and only use those notes to perform the calculations. It states in their notes (notice the asterisk), “Includes all accounts with purchased Notes between July 1, 2009 – January 4.” January 4 + 10 months = November 4. 2011Make sense?

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Roy S
Roy S
Dec. 12, 2011 8:50 pm

I wish they would have changed the table you posted above to go with the chart you left out, which breaks down the returns for the under 100 Note club into three subsets: 1 – 19, 20 – 49, and 50 – 99. I’m wondering how many of those 12,685 accounts have fewer than 10 Notes. I can see a lot of people opening an account to try it out and only put in the minimum $25 or $50 or $100, and then never really progress from there (for who knows what reason). I think once you break it down into the active accounts (I’m leaving what determines an account as “active” a little nebulous since I think everyone has a slightly different opinion of what constitutes an active account) and non-active accounts, you might see a different picture.

Also, they stated, “Includes all accounts with purchased Notes between July 1, 2009 – January 4, 2011 which do not have any participation on the FolioFn trading platform.” By this, I take it they excluded any account that had either bought or sold a Note on FolioFn? I’m not sure whether the modifying phrase is applied to “accounts” or “purchased Notes.” But even just excluding certain Notes changes the real returns people are getting. Peter, I’m not sure that you can necessarily state that people with 400+ notes are earning a full percentage point higher than their state average return for all investors–I am sure that you can state it using the numbers they present, I’m just not sure that it is true (it’s more a case of garbage in, garbage out).

Overall, I’m not sure I really care for this post as it is beginning to remind me of their post on the changes they made to the rates for repeat borrowers. The more I look into this, the more I feel that they are trying to pull over a fast one on me. Maybe it’s better that I stop reading what they are posting on their blog and just be content with my current returns…and I am happy with my returns and the service Prosper provides, just not their…well, shall we say, “marketing.”

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Peter Renton
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Peter Renton(@peter)
Dec. 12, 2011 9:17 pm

@Dan, As Roy points out the chart represents returns through the end of October (Nov 4th to be precise) but on notes issued between July 2009 and January 4th, 2011.

@Roy, My guess is that a good chunk (probably 50% or more) of accounts have less than 20 notes although I have no information to back up that claim. From reading their explanation it looks like any account was excluded from this analysis if there was any Folio trading activity.

Regardless of all that, my point with this post was to emphasize the importance of diversification. Even allowing for the fact that they excluded some percentage of accounts, it is clear that having at least 100 notes in your portfolio greatly improves your chances of a positive return on your investment at Prosper.

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Charlie H
Charlie H
Dec. 13, 2011 11:36 am

Diversification is the only free lunch in investing. This is true both with in an asset class and between asset classes.

Just looking at these numbers my gut would say that something else is going on to explain the difference in returns between 100 note cohort and the 400+ note cohort. I would guess that some one investing in 400+ notes is likely using a more sophisticated note selection process and hence the outside returns…

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Dan B
Dan B
Dec. 13, 2011 2:55 pm

One point that I take away from this is that Prosper continues to have large amounts of small &/or inactive investors. According to the above info, there were 14,140 investors that invested any amount between the magical date of July 2009 & Jan 2011. These active investors, on average, invested around $4000 each over a period of a year & a half to fund these 7700 loans.

2 months later, (March 2011) Prosper reported to the GAO that they had a total of 60,000 investors! Impressive, I thought, considering that Lending Club reported 20,600 at the time.
But even allowing for the unlikely possibility that Prosper were able to sign up 1000 investors in those 2 months (Feb, Mar2011) that still leaves us with around 44,000 investors that had essentially left, were no longer investing or reinvesting. That’s roughly 3 out of every 4 investors that had ever signed up.

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Peter Renton
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Peter Renton(@peter)
Dec. 14, 2011 6:49 am

@Charlie, I thought about that as well. What I came up with is that if someone has a lot of notes they are probably a more serious investor. So they have probably done a bit more homework. Because I would have thought that 400+ portfolios would have a lower average return than the smaller portfolios.

@Dan, Obviously, they have a huge number of inactive investors left over from the Prosper 1.0 days. This is not surprising given the poor returns that most of these investors received. Many of them are probably convinced that you can’t make money in p2p lending because of their own experiences in 2006-2008.

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Michael
Michael
Dec. 14, 2011 10:09 am

@Charlie H
You are 100% correct. Diversification is not why the returns are going up. People with larger portfolio have less fear of higher risk notes taking down their entire portfolio – they take on more risk, as result have higher returns. And as you stated, they are most likely using LendStats. I think the chart is slightly misleading because they seem to be correlating diversification to higher returns (the second chart should have been the focal point). You have to read the article closely. They are NOT making the case that diversification increases returns, they are making the case it makes returns more predictable. I agree.

Assume every note on the platform had exactly a 6% default rate. If you buy 100, 1000 or 1000000000 notes you can reasonably expect about 6% of notes to default. Obviously the higher the number of notes the smaller the deviation from 6% – hence a more predictable return, not a higher return.

In other words if I buy 10,000 C notes with the same interest rate, it’s statistically improbable I would out perform an investor with 1000 of the same notes by more than 0.2%. In fact the investor with 1000 notes has a better chance of a higher return.

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Peter Renton
Author
Peter Renton(@peter)
Dec. 14, 2011 9:02 pm

@Michael, Good points. With just a glance at the chart you might think 400+ loans automatically mean a highly likely return but as you point out that is simply not the case.

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Bilgefisher
Bilgefisher
Dec. 16, 2011 7:47 am

Peter,

You know I have disagreed with the notion of diversification in the past. All diversification does is lower your variance. That’s it. For prosper to show that it increases your ROI only shows a few pieces of a much larger investing puzzle.

One example, I would hypothesize that smaller investor are likely to be less sophisticated than large investors. Many invest in one note or have no system set for picking notes (ie they read the stories and sympathy invest).

As stated previously this reminds me of their repeat borrowers post. I invest in prosper, but I begin to question their integrity when that continue to post what I perceive to be misleading and cherry picked information.

Jason

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Peter Renton
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Peter Renton(@peter)
Dec. 16, 2011 9:27 pm

@Bilgefisher, I think the main purpose of the article was to show the consistent returns you get from diversification. But I don’t blame them for putting in the chart. It may encourage some of the people who are in the 1-99 note group to put some more money in.

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Bilgefisher
Bilgefisher
Dec. 19, 2011 8:39 am


I don’t disagree with the intent. I would guess they want jaded borrowers who lost $500 from one note invested. I just don’t think their chart tells the whole story.

I think the average long term investor will have diversification by default. If all they can afford is $100/mo, then likely they have at the very least 12 notes per year. Not the diversification you suggest, but better then 1 $1200 note.

Jason

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Peter Renton
Author
Peter Renton(@peter)
Dec. 19, 2011 4:07 pm

@Bilgefisher, That is one of the great things about investing on a regular basis – it forces diversification as you point out. I am more concerned with the investor who gets all excited and drops in $10K in just four or five notes to “see how everything goes”.

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Dan B
Dan B
Dec. 19, 2011 6:57 pm

Peter………..That’s exactly right………….& a surprising amount of people do in fact do exactly that.

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