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Won’t You Be My Neighbor

February 23rd, 2021

Market Views

While discussing the paradox confronting today’s fixed income allocators, we thought of Mr. Rogers and his famous invitation to everyone.

In one established, traditional neighborhood, you find fixed income investors clamoring to purchase 10, 30, 50 and yes, 100-year sovereign bonds at rock bottom coupons.  Earlier this week, Spain sold €5 billion in a 50-year bond with a 1.45% coupon…against orders of €65 billion!  Last week, Portugal sold €3 billion in a 10-year bond with a 1% coupon… against orders of €40 billion.   Yields on Italy’s 10-year bond are heading for the zero line.  Yields on the U.S. 10-year are hovering around 1.2%

A few streets over, a new neighborhood has emerged where fixed income investors enjoy a different proposition.  Coupons and yields – net of expected credit loss – are higher. Terms are much shorter; the lexicon is months, not years or decades.  Individual balances are orders of magnitude lower, mitigating the impact of single-issue default risk.  Most of the time, the debt is amortizing; that is, it pays back principal and interest at least monthly, sometimes more than once during a month.  And, the underlying credits are tied to the real economy, not government printing presses.

New financial companies powered by technology and data anchor this neighborhood.  They have become the “go-to” credit source for individuals, families and small businesses.  These companies embrace rule-based underwriting, efficient servicing, and transparent reporting…all of which lead to a better credit experience for both borrower and investor.  The neighborhood is up and coming:  By market cap and as of this writing, PayPal is the second most valuable financial services company in the U.S., and Square is worth as much as Goldman Sachs. Recent public offerings have given marketplace lender Upstart, point-of-sale credit provider Affirm, and student loan pioneer SoFi aggregate market caps of about $50 billion.  LendingClub became a bank a few weeks ago.

Some folks have accepted the invitation and ambled over to explore the risk-adjusted return profile of this neighborhood’s credit assets.   At a time when the quest for yield – seemingly any yield – is in full throttle, we believe more should accept the invitation.   We recognize there is a need for clearer advertising and better education.  For example, how does a prospective investor compare different offerings?  What are the risks and potential pitfalls and how does an investor spot them easily and quickly?  What are the key due diligence questions?  It is the local residents’ (i.e., professionals in the industry) responsibility to meet this challenge and provide the education.

Credit allocators should expand their horizons in order to understand the promise of digital private credit.  Break tradition, come to our neighborhood, and take a walk on what we see as the sunny side of the street.  Returns from short duration, small balance, amortizing credit have significantly outperformed most credit indices, with a fraction of the volatility.

Won’t you be our neighbor?



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