Lat week while I was reading this post from AQR I had a sudden revelation: what if I can borrow Cliff analysis and use it to explain Bondora Go&Grow (alleged) success?
The AQR paper is about Private Equity, why investors are (particularly now) so in love with the asset class, if PE offers a better risk/return profile compared to public markets and from where this outperformance comes from.
big time multi-year illiquidity and its oft-accompanying pricing opacity may actually be a feature not a bug! Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns?
Liquidity vs Illiquidity
I want to first clarify a point about liquidity: according to standard financial literature, the more an asset is illiquid, the more it should pay an investor, the so called the illiquidity premium. The dilemma for Cliff and others is that in the real world, PE is illiquid BUT offers lower returns (net of fees) than liquid assets and investors are happy with it. In this sense, Go&Grow acts as it should: instead of getting >10% returns from a ‘standard’ p2p platform, where your investment is locked for the life of the underlying loans (3 to 5 years), you get 6,75%* but daily liquidity.
Ehm…’daily liquidity’ is what bloggers sell you with their referral code. If you read Bondora website, they refer to faster liquidity, meaning you can cash out your investment with minimal effort, they never assure you that you can have your investment back in a short period of time under every circumstance. In this interview, the legal definition is clearer: When someone invests in Go&Grow, they buy a claim of the Go&Grow portfolio. When they liquidate their account, they sell those claims back. It is a glorified secondary market. The yield difference (c10% – 6,75%) should represent an (alleged) reserve fund that Bondora can use to liquidate investments faster. Everything according to theory so far, more liquidity and less return, just do not be that (p2p) investor that see the risk but thinks: I will not be the one left with the hot potato (a.k.a. there will always be liquidity for me but maybe not for others). And please do not invest thinking there is daily liquidity because it is not true.
(the interview I linked is also“interesting” because reading it you think the guy is quite into Bondora; then you dig a little deeper (obviously not disclosed in the same post) and discover that he has almost €80k invested in p2p platforms and… 0,66% of it with Bondora… ever heard about putting your money where your mouth is? Nothing says trust like risking a sum that you can make back in 10 working days of passive income).
Opacity
Here is where I think Cliff helped me to understand why people like so much G&G. G&G and other Bondora products like Portfolio Pro are sausages made out of the same ingredients: loans originated by Bondora. You can recreated the G&G portfolio with Portfolio Pro and get a higher return, in exchange for less liquidity and a return profile that goes up and down instead of being a (fictitious) straight line. Like PE compared to public markets, the return volatility is there but the product does not show it, so you can sleep tight and dream about your risk-free gains. This is what I think is the main allure of G&G for the majority of investors: you see your gains growing in a linear and systematic fashion, away from a reality made of defaults and losses that can scare you and push you to sell everything.
The crucial difference here is that public markets, and the US stock market in particular, have a positive expected return: corrections and crashes are part of the game, if they drove investors away or force them to sell at the wrong time, any (reasonable) strategy to keep them invested is more than welcome. Bondora has still to prove that their loans have a positive expected return; shielding investors from volatility and drawdowns can lead to a very bad surprise at the end of the road.
Conclusion
If Bondora had a proper risk and origination departments (more on this later) I would still be puzzled by the use of G&G. Even Bondora itself does not sell the product as a current account but as a way to save towards goals like buying a new car: do you need short term liquidity for that? And do you need to sacrifice 4%/year of returns for that? The main reason you invest in high yielding products is that the gains compound faster but you receive the benefit of compounding over years, so why should you care about the very short term?
Financial history is full of companies that tried to solve the liquidity mismatch and they almost all ended badly; recently I have to deal with a new European Regulation on Money Market Funds exactly for this reason. Giving a false sense of liquidity is dangerous because it creates wrong expectation in investors, especially the non sophisticated ones.
My main concern is that the ingredients Bondora uses to make its sausages are rotten: they have a very big number of Non Performing Loans and this aspect null all the arguments made above. The 6,75% comes from their poor origination models, not from a prudent management and the use of a reserve fund for liquidity shortage. Why I say so? It’s been five years (a full loan cycle) that I use their Portfolio Pro and I see first-hand their loan performance. I cannot even speculate they keep their ‘best’ loans for G&G and dump the crappy ones in the other products because now 70% of the money in Bondora are in G&G.
What is your opinion about Go&Grow? Leave a comment below.
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