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Post: Investment On Online Lending Platforms Can be More Profitable than Stocks, Bonds and Real Estate



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Online Lending Platforms

By Moris Strub and Ram Gopal

The world of finance has witnessed a remarkable transformation in recent years, with online lending platforms emerging as one of the most successful manifestations of financial technology.

This sector has experienced significant global growth, with the UK market boasting a staggering 20.7 per cent annualised growth rate from 2017-2022, reaching a total value of $335.8 million.

The surge in online lending has disrupted traditional financial systems by offering an efficient, accessible, and technologically-driven alternative. New research from the Gillmore Centre on online lending and its potential to outpace stocks, bonds and real estate in terms of profitability recommends that institutional investors gain a seat at the table, warning that they may miss the boat due to a lack of awareness and understanding of the asset class. Let’s explore this further.

The Digital Evolution of Lending

One of the defining features of online lending platforms is their seamless integration of the entire loan approval process into the digital realm. This includes functions such as credit risk assessment, interest rate determination, and the matching of borrowers and lenders. This digital transformation has not only increased efficiency, but also opened doors for individuals who may not have had access to traditional banking services. 

Regulatory Changes and Investor Protection

The rapid growth of online lending has also been accompanied by regulatory changes intended to improve individual investor protection. These measures have led to a shift in the investor base from individual lenders to institutional investors. Despite this shift, it remains a matter of debate whether online loans can offer attractive returns that justify their inclusion in an asset allocation strategy.

Machine Learning: The Game Changer

The process of constructing portfolios of online loans is intricate because traditional approaches cannot be directly applied. Research from the Gillmore Centre for Financial Technology at Warwick Business School, in collaboration with academics from the City University of Hong Kong and the Laboratory for AI-Powered Financial Technologies, has shown that machine learning techniques constitute a viable approach to tackle this problem. This led to a recent research paper Gaining a seat at the table: enhancing the attractiveness of online lending for institutional investors.

The newly developed framework, known as General Characteristics-based Portfolio Policies (GCPP), has demonstrated the ability to achieve an average rate of return ranging from 8.86 per cent to 13.08 per cent per year using extensive data sets of online loans collected from LendingClub. This performance significantly outperforms an equal-weight portfolio of loans, making a compelling case for the adaptation of sophisticated techniques for portfolio construction.

Online Loans vs. Traditional Assets

Now, let’s return to the broader question: Is it worthwhile to invest in online loans when compared to more traditional assets like stocks and bonds? The answer, when sophisticated portfolio construction techniques are applied, is a decisive ‘yes’. A portfolio of online loans constructed using the GCPP framework yields an internal rate of return (IRR) nearly twice that of the S&P 500, while also providing diversification benefits. The importance of sophisticated portfolio construction cannot be overstated, and a simplistic approach to building an online loan portfolio would not come close to matching the IRR of the S&P 500.

When comparing online loans with other popular asset classes, their impressive performance is highlighted. A GCPP-based portfolio of online loans outperforms the Bloomberg U.S. Aggregate Bond Index by over four times and exceeds the IRR of the MSCI U.S. REIT Index (a popular benchmark for real estate investments) by more than double. These findings underscore how online loans represent an attractive, novel asset class with high rates of return and low correlation to traditional investments, expanding the investor’s opportunity set.

Diversification and Risk Mitigation

The success of online loans as an investment option ultimately depends on their ability to offer attractive returns to sophisticated investors. The answer to this critical question is almost indisputable: online loans constitute an attractive new asset class when advanced techniques for portfolio optimisation are applied. Consequently, we predict that the ongoing shift in the investor base toward institutional investors will be both successful and sustainable.

Recommendations for Institutional Investors

In light of these findings, it is strongly recommended that institutional investors consider online lending as an important part of their asset allocation strategy. By diversifying their holdings to include online loans, investors with substantial exposure to traditional assets can enhance their overall portfolio return while mitigating risk

The desirable returns and diversification benefits of online loans should encourage greater institutional participation, further fostering the growth of online lending markets.

Closing Thoughts

The rapid evolution of FinTech has presented a plethora of benefits to various sectors, and welcomed a new era of investment opportunities. Online lending platforms have significantly emerged as a promising alternative to traditional assets like stocks, bonds, and real estate, and our recent research has indicated that, when sophisticated portfolio construction techniques are applied, online loans can deliver significantly higher returns, outperforming traditional benchmarks and offering valuable diversification benefits.

As the investor base in online lending continues to successfully shift towards institutions, those who embrace this opportunity early are likely to reap the rewards.

About The Authors

Ram GopalRam Gopal is Director of the Gillmore Centre for Financial Technology at Warwick Business School. He is also the Information Systems Society’s Distinguished Fellow and a Professor of Information Systems and Management. He was previously the Head of the Department of Operations and Information Management in the School of Business, University of Connecticut from 2008-2018. He is currently a Senior Editor of Information Systems Research and has held editorial positions at Decision Sciences, Journal of Database Management, Information Systems Frontiers, and Journal of Management Sciences. He served as the President of the Workshop on Information Technologies and Systems from 2016 to 2018.

Moris StrubMoris Strub is a member of the Gillmore Centre for Financial Technology at Warwick Business School. He is also an Associate Professor with the Information Systems & Management group. Before joining WBS, Moris was an Assistant Professor for Financial Engineering at the Southern University of Science and Technology Business School. He obtained a PhD in Financial Engineering from the Chinese University of Hong Kong and holds a BSc in Mathematics and MSc in Applied Mathematics from ETH Zurich, both obtained with distinction.

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