[Editor’s Note: This is a guest post from James R. (“Jim”) Hedges, IV. He was one of the early leaders in the hedge fund and alternative investments industry, and is the author of Hedges on Hedge Funds. He was the Founder and Chief Investment Officer of LJH Global Investments, LLC, an alternative investment advisory firm which advised on over $5 billion of alternative investment allocations. In 2017, Mr. Hedges founded HEDGES COMPANY (www.hedges.company) to provide insights on alternative investments to entrepreneurs, investors and fund managers. The firm is especially focused on specialty finance and co-investment opportunities. Mr. Hedges is also a partner in LJH Financial Marketing Strategies, LLC (www.ljhfm.com). He lives in Los Angeles, California.]
When I began working in the family office and hedge fund worlds in 1992, private investors were looking, foremost, for return enhancement and, secondarily, for diversification. Fast forward 25 years, investors are still looking for return enhancement, but less on the equity side, and rather more for current income. In the early 1990’s, hedge funds were a secretive, largely unregulated landscape with virtually no disclosure and very little educational information available for those looking to allocate capital to the space. As a result, investors often did not know how to differentiate fund managers and tell the difference between an A- player and a C- player. There was a profound lack of thought leadership, and those charged with advising new entrants in the market had to do a great deal of educational missionary work and lay out a thoughtful path of insights.
In today’s marketplace lending sector, it is a similar story. There is a proliferation of funds in the space, and assets are flowing in to funds to the tune of hundreds of millions of dollars per quarter. There are ample industry-focused conferences and e-publications, but there remains precious little in the way of independent research and insight for private investors, institutions and the consultants who serve both groups. Product differentiation is difficult, and there is still not a robust set of data analytic tools or benchmarking indices.
In terms of the landscape, on one side of the field, we have a universe of loan originator platforms. Best known names like Lending Club, Prosper and SoFi have dominated the press, but there are, in my estimation, well over 100 unique specialty finance loan origination platforms, and within that group, loans are being originated in an ever-increasingly diverse set of sectors, such as:
- Unsecured consumer credit for debt consolidation and emergency expenditures
- Real estate lending (often secured by real property)
- Small business credit
- Merchant Cash Advance
- Equipment Financing
- Retail installment contracts (RIC’s)
- Solar equipment financing
- Education financing
- Automotive repair financing
Each of these segments has unique drivers impacting customer acquisition costs, underwriting procedures, and borrower behavior. Consequently, many of the segments offer differing yields, default rates and durations.
On the other side of the marketplace lending landscape, once the loans are originated, there are many different asset management structures through which capital inflows are being allocated, including:
- Managed Accounts for institutional investors
- Hedge Fund Vehicles (i.e. private partnerships: funded all at once with shorter lock-ups)
- Private Equity Vehicles (i.e. private partnerships with investment drawdown periods and long-term lock-ups)
- Fund of Funds investing across a spectrum of originator strategies
- UK-listed Funds (i.e. closed end funds, most of which trade at meaningful discounts to their NAV)
- Luxembourg SICAV’s
- 40 Act Funds (interval funds which mostly have staggeringly high fee burdens)
- Notes and Variable Life Insurance wrappers for tax efficiency