The previous decade has seen the rise of robo-advisors; automated platforms that help investors to allocate their capital. Robo-advisors now include options from insurance to specific stock picks as well as thematic portfolios of stocks, based on the appropriate risk/reward ratios of the users.
At the same time however, we have also seen the rise of a growing asset class – SME lending. Through crowdfunding (or crowdlending) from a group of individual lenders (also known as investors), P2P platforms such as Validus provide the opportunity to accredited investors seeking to diversify their portfolio and increase resilience
SME lending involves short term loans of up to 12 months, at minimum amounts of as low as $1,000. This allows accredited investors to derive returns as high as 8 to 12 percent per annum. Because these loans are based upon projects which have been completed, and repayment risks are mitigated with ring fencing mechanisms are based upon projects which have been completed, and repayment risks are mitigated, they tend to remain stable in performance regardless of the economic situation. With the higher yield SME financing offers, this product is a valuable addition to make for any experienced HNWI. Loan tenors and risk profile can also be selected according to each investor’s appetite.
But how do these two rising alternatives compare to the traditional methods of reading financial reports, understanding charts and indicators, and picking your own stocks and bonds?
It’s a particularly pertinent question given the low interest rate environment driven by Covid-19, which is set to last till at least 2022. Younger investors are seeking more ways to grow their long term capital, and these three methods are among the most promising.
What are the main differences between the three methods?
Some of the key considerations are:
- Robo-advisors are not an investment class in and of themselves.
- Absolute versus variable or benchmark returns.
- Passive versus active investing.
- Complexity in gauging performance.
- Transparency and regulation.
- Liquidity issues
1. Robo-advisors are not an investment class in and of themselves
Rather, robo-advisors are algorithms that help to pick what you invest in. This means that, when you use a robo-advisor, you could be investing in a wider range of asset classes than you expect.
Depending on the robo-advisor, your capital could be allocated to products such as:
- Unit trusts
- Indexed funds
Some robo-advisors may also include insurance products, such as endowment plans, or even commodities and Forex. This means that the returns you get from a robo-advisor depends on the performance of the various products it chooses.
If you want to understand exactly what you’re invested in, you’d also need to understand the various products to which the robo-advisor is allocating your money. It also becomes difficult to estimate the potential returns, as the various assets bought by the robo-advisor will all perform differently.
Also note that explainability (i.e. the ability of the artificial Intelligence of a robo-advisor to explain its decisions) is an ongoing development; robo-advisors may be unable to tell you why your money has been invested in a certain way, even if the AI has its reasons.
This can, ironically, end up making robo advisors more complex than SME lending or picking your own stocks and bonds.
2. Absolute versus variable or benchmark returns
SME lending and vanilla bonds provide absolute returns. These are both forms of debt, for which there is a fixed repayment – the current state of the economy impacts performance less directly. This makes SME lending an important defensive asset, in the current Covid-19 downturn.
This differs from equities or equity funds, in which changing share prices or dividend payouts are unpredictable. In most cases, equity funds will have a benchmark index (e.g. the STI, Dow Jones, NASDAQ), against which they will peg their performance; returns will tend to be close to the chosen index.
As such, returns are less predictable for investors who use managed funds, or who have bought into unit trusts via a robo-advisor. For SME lending platforms such as Validus, absolute returns of between eight to 12 per cent per annum are possible.
The Singapore Savings Bonds (SSB) rate currently stands at about 0.89 per cent (if held to maturity over 10 years) at the time of writing. Bond interest rates are expected to remain low due to the Covid-19 situation, which has caused an interest rate cut in the United States.
3. Passive versus active investing
Picking your own stocks and bonds is a form of active investing, and it is an involved process. It is up to you to conduct the fundamental and technical analysis of the various companies, understand their financial statements, have a sense of government policies that could affect their business, etc.
While it offers the greatest degree of control, it can be difficult for time-starved investors; it also carries the risk of emotional biases, such as sunk-cost fallacy, or the urge to “double down” on a previously successful investment.
Robo-advisors are the opposite – they will take over all the decisions on which assets to buy, hold, or sell. They are entirely passive, which makes up a large part of their attraction. Robo-advisors, being algorithms, are also immune to emotional biases; they always stick to the strategy they’re coded to follow.
However, using a robo-advisor requires you to trust that the algorithm works, and that the robo-advisor you’re using is a top performer (as mentioned below, this can be very hard to determine for the layperson).
SME lending is somewhere between the two. You are required to decide which SMEs to lend to. Some online platforms like Validus offer SME lending opportunities exclusively to accredited investors, and provide insurance for capital protection, use escrow accounts, and thoroughly vet all borrowers.
Once the decision is made, however, it’s mainly a passive process as there’s no need to “buy and sell” like stocks; just wait for the repayments to come in as specified.
4. Complexity in gauging performance
Gauging the performance of SME loans and SME lending platforms is straightforward. You can see the returns you’re getting (they’re all fixed), and you can see the risk profile of the companies involved.
Gauging your performance if you’re picking stocks or bonds is theoretically simple. It’s a matter of setting clear financial goals, and then evaluating which of your assets are advancing you toward those goals. However, complexities can arise if you’re misinterpreting the performance of the various assets; or if you have biases toward certain companies or industries, that makes you excuse underperformance.
For robo-advisors, comparison is difficult. Most robo-advisors don’t specify their annualised returns the same way that you’d find in a fund factsheet. Likewise, it’s hard to acquire the data on how various robo-advisors are performing. You often won’t know until you’ve tried a few different robo-advisors, and can take notes for future comparison.
5. Transparency and regulation
Transparency and regulation differ between SME lending platforms; it’s important to check for accreditation before using one. SME lending platforms in Singapore, such as Validus, are regulated by MAS.
This is not always the case in SME lending platforms abroad, so investors should be wary of the risks.
Robo-advisors in Singapore are also well regulated by MAS. However, robo-advisors operating in foreign jurisdictions present a much higher risk (e.g. a foreign robo-advisory may close down with your money still in their account, and you would be hard pressed to take legal action in a foreign country).
If you choose to pick stocks and bonds yourself, the degree of transparency depends on your financial literacy; everything is as clear as your understanding of what you buy. In Singapore, MAS does restrict certain products to accredited investors. You may have to qualify as an accredited investor and also opt-in, before you can buy certain assets (this is to ensure you have sufficient understanding of what you’re buying).
6. Liquidity Constraints
When you buy stocks, bonds, unit trusts, etc., there is some risk of loss if you need to sell your assets in a hurry. For example, a robo-advisor may pick some ETFs that will provide good long term returns – but if you urgently need cash and sell the units sooner than expected, you could incur a capital loss. The same goes for selling any stocks or bonds that you picked yourself.
SME lending helps to mitigate some of these issues, due to the short loan tenures. If you need to maintain liquidity, for instance, you could stick to loan tenures that are as short as six months or less (SME loans generally don’t extend beyond 12 months at most). This will ensure your capital isn’t locked up for long periods, an important consideration during volatile markets.
Photo by Lukas from Pexels
Your investment portfolio doesn’t need to be an either / or situation
It’s entirely possible to use a mix of all three – you might have one portion of funds managed by a trusted robo-advisor, another portion in SME lending, and also occasionally buy stocks or bonds that you feel are appropriate.
The three methods are not exclusive; in fact, using a diversified approach might provide a safe and lucrative approach to investing. Wealth managers, as well as individual investors, should consider how SME lending asset class can contribute to their existing portfolios; and whether a reasonable amount can be trusted to automation.
As an added bonus, SME lending also allows investors to make a positive impact on the local business environment. Robo-advisors and stock exchanges tend to only involve bigger, listed firms; but SME lending can include dynamic new companies with important environmental contributions (e.g. TRIA, which creates ecologically friendly packaging and found funding from Validus), or which contribute to social development.
It also means you’re able to invest in a wider range of companies with low correlation; this level of diversification helps to mitigate the volatility caused by Covid-19.