“If you want to gather honey, don’t kick over the beehive.”
Dale Carnegie
Carnegie was talking about how to make friends and influence people, but for our purposes the quote helps to explain our approach to building diversified portfolios of small balance, low duration loans.
A beehive is an incredible enterprise, with tens of thousands of bees working together tirelessly in perfect synchronicity. Each bee has a specific job, and each is designed to execute its assigned task with maximum efficiency. A worker bee, for example, is assigned housekeeping chores in the hive until it is strong enough to fly off and gather pollen. A single worker bee may fly a cumulative 500 miles in its one month of life and then die of exhaustion at its last moment of usefulness.
An optimally diversified portfolio of digital loans is much like a beehive. Tens of thousands of small balance, short duration loans work tirelessly to contribute return to the portfolio, with each loan expected to make a small, but reliable contribution to the aggregate pot – no more than its share – and no single loan big enough to kick over the hive. The loans have another equally important task: to provide regular cash flow by amortizing over their term — whether daily or monthly — until the loan balance hits zero. This combination of extreme diversification and high liquidity is at the essence of mitigating risk and providing the optionality required to seize market opportunities.
The beehive and a diversified loan portfolio are perfect examples of the Law of Large Numbers at work: their constant renewal and regeneration allows them to weather stress and withstand individual losses. At the same time, the liquidity provides a portfolio manager with optionality — to reinvest, move to the sidelines, return cash, and/or act quickly on opportunistic and attractive purchases – that is likely unmatched in other private, non-traded assets.
The hive is a model of efficiency, but there are no shortcuts. To produce one pound of honey, a hive of bees will fly 55,000 miles and visit more than 2 million flowers. Yet, the average worker bee will make only about 1/12 of a teaspoon of honey in its lifetime. Similarly, a FinTech-driven portfolio will review millions of loans and present only those meeting the exacting criteria required to be considered for investment.
While bees may live for just a few weeks, a well-constructed hive can survive and produce honey for more than 100 years. At HCG, we are committed to building a technology engine that can support our investment teams for decades to come, and an enterprise our investors can count on to withstand the challenges ahead.
For Carnegie, keeping the beehive humming depended on maintaining many friends by limiting his critiques of them. A FinTech hive needs to be built on constant, highly critical assessment and evaluation of its underlying diversification and liquidity. While Dale may have had more friends than us, our goal differs from his in that we strive to keep our focused group of investors happy.
Industry Update
We highlight what we believe were the first quarter’s important developments and trends that impacted digital finance investing:
- The Fed went on hold, per our expectations: Following its meeting in March, the Federal Open Market Committee published its Summary of Economic Projections with members’ expectations for zero rate hikes in 2019, a decrease from expectations for two hikes at the December 2018 meeting. We continue to believe that weakening global growth and cooling U.S. macro leading indicators, coupled with low inflationary readings, will likely keep the Fed on hold for the rest of the year.
- Regulatory drumbeat increased in certain states and sectors: Several U.S. states have announced inquiries into lending practices in certain segments of consumer and SME borrower categories. While we believe digital finance originators operate in a more borrower-friendly manner than many traditional lenders, we continue to keep close watch on these developments. Furthermore, as members of the Marketplace Lending Association, we attended the group’s annual meeting in March in Washington, D.C. to speak with many of the top Fintech CEOs and lawmakers about these legislative efforts and potential paths forward.
- World’s largest retailer – Wal-Mart – announced partnership with FinTech operator: In February, Wal-Mart and Affirm announced a new partnership in which Affirm will provide point-of-sale financing to online and in-store customers. We highlight this development as yet another example of how digital finance innovation is displacing traditional bank products – in this case Affirm taking share from legacy credit card providers. To bolster its ability to service Wal-Mart, Affirm raised $300 million in a Series F financing round.
- Money center banks stepped-up digital finance efforts: In March, Goldman Sachs and Apple announced the Apple Card, a new, innovative credit card that is built on “simplicity, transparency and privacy.” While Goldman has been active in digital finance with the Marcus brand for some time, the new announcement highlights a new strategy to tap into the digital customer segment. Additionally, J.P. Morgan announced at its investor day in February both the “My Chase Plan” and “My Chase Loans,” which enable borrowers to finance large purchases over varying time periods and at fee structures of their choice. These types of offerings could be positioned to compete directly with digital finance providers.
- Wave 3 arrived: In prior commentary, we characterized this latest wave of FinTech as one that would harness new opportunities around cash access. New firms have been innovating and creating solutions devoted to this topic, ranging from the monetization of heretofore intangible, inaccessible assets to increased velocity of that access. We believe this wave is intensifying rapidly, bringing with it a level of empowerment to consumers and businesses, while at the same time the potential for considerable disruption of existing business models.