It’s often said that it’s better to be the lender than the borrower. That’s how banks make so much money, but being on the “right” side of the lending equation is difficult for many ordinary investors.
Sure, that’s technically what they’re doing when they own bonds or fixed income funds. Buying bank stocks or funds is also along the same lines, but these are prosaic approaches. Fortunately, investing is increasingly democratized, allowing market participants to get a taste of what it’s like to be a banker/lender.
For example, several personal loan providers allow everyday investors, even those with limited capital, to invest in peer-to-peer loans. In many cases, these platforms allow investors to select, by credit grade, the borrowers to which they want to lend. As is the case with traditional bonds, the lower the borrower’s credit score, the investor’s risk profile is elevated, but so is the yield.
Another way of getting in on this act, and one that advisors may want to research is household loans, which often amount to personal loans.
Exploring Household Loans as Investments
What separates household loans from personal loans – and this is important – is that the former usually aren’t used for consumption. The latter aren’t supposed to be, but let’s be honest. Some folks take out these loans for frivolities. Rather, many household loan borrowers use the capital to pay down higher interest mortgages or car debt.
Adding to the allure of household loans as an investable assert class is the point that owing to the size of many of these borrowings, it’s usually affluent folks with strong credit scores doing the borrowing. That’s good news for creditors and investors. There are more positive attributes.
“Household loans generally have a three to five-year maturity. Monthly amortisation means the loans are paid down to zero over the term,” notes Tonko Gast of BNP Paribas. “This amortisation is what’s attractive: the duration profile is short relative to other private credit asset classes or even other publicly listed corporate bonds.”
That duration profile makes household loans less sensitive to changes in interest rates and smooths out some of the turbulence associated with marking other fixed income assets to market.
“Such a short duration profile makes the mark-to-market volatility low, typically at less than 1% a year,” adds Gast. “Even when yields go up – as has been the case recently – the mark-to-market adjustment on the asset class is limited to about -3.5%. For other fixed income asset classes such as corporate, senior or leveraged loans, the mark-to-market can be as high as -15%, as we have seen recently.”
While the current interest rate environment is far from sanguine, now may be an ideal time for advisors to discuss household loans with income-starved clients because lenders are tightening credit standards. At least in theory, that should mitigate credit risk.
The Predictability Perk of Household Loans
No one has a crystal ball and forecasting what’s next for interest rates in the U.S. is mostly a fool’s errand. That highlights another virtue of household loans: They’re relatively predictable.
Sure, there are always instances in which strong borrowers default, but the long-term history of household loans confirms an enviable record of predictability.
“We see the performance of household loans as predictable. It has been a straight line – in US dollar terms – we have seen no monthly negative returns over the last three years on our portfolio, even with the pandemic, the war in Ukraine, inflation spiking and interest rates rising,” concludes Gast.
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