COVID-19 recession: Active management can significantly reduce losses

 

One of the most common subjects of debate in the fund management industry over the last decade has been the notion that, as investment managers rarely outperform the market, investors should pay as small a management fee as possible in order to increase their net returns. Yet, when investing in markets where full information is simply unavailable, paying a reasonable fee for good investment management can have a positive impact on returns.

In a crisis, active management can help investors navigate the volatility of the financial markets. During the first weeks of the COVID-19 pandemic, many investors tried to liquidate positions acquired because of “investment robots” or “algorithms”. Suddenly, these investors realised that passive management, while undoubtedly having some benefits, also has a number of disadvantages compared with active management.

Active management

Crowdlending is evolving quickly, and loan origination is increasing year after year, but they still belong to a niche market in which knowledge offers a significant advantage. High nominal interest rates may be obtainable on several platforms, but many investors are “blinded” by those interest rates, and few pay any attention to the potential losses that can occur.

Investor losses can occur in several ways, the most common being that the loan originator is not good at assessing the creditworthiness of a potential borrower, so that, over time, the investor can lose money and receive a much lower-than-expected return.

Potentially more serious losses can arise from fraud or embezzlement. Earlier this year, two platforms in Estonia were suddenly shut down, and a domestic police investigation is currently underway, with Estonian police asking investors to report their losses.

While losses can never be fully avoided, professional investment management can nevertheless help minimise them.

Quantrom – our process to minimise losses

At Quantrom, we take great care when investing via new platforms and loan originators, and we have a clear selection process when it comes to choosing those with whom we want to work.

Before even approaching a platform or loan originator, we monitor their activity for some time. A major consideration in this regard is volume. As with all Fintech solutions, volume is essential (the most sophisticated solution is not always the decisive factor for us), and platforms that cannot grow are to be avoided.

If we believe that a platform has potential, we examine the loans it offers. Quantrom does not invest in payday loans (short-dated loans with extremely high interest rates and fees), which rules out a number of platforms.

When we are satisfied that platforms/loan originators are bona fide and offer loans that we would invest in, we will begin a dialogue with them.

For us to then proceed, we will:

  1. Initiate contact with them via video conference.
  2. Conduct full due diligence on each platform/loan originator.
  3. Request their entire loan book for us to examine statistically.
  4. Request a letter of good standing.

If the outcome is positive, we will open an account and invest a small amount to test whether what has been promised can be delivered.

If our expectations are then met, we will personally visit the platform/loan originator for further discussions before committing to a larger investment.

Has our approach paid off?

Despite the COVID-19 crisis, Quantrom P2P Lending has had a return of more than 2.4% so far in 2020. Even in March, when the financial markets took a severe hit, we managed to earn a positive return of 0.35% for our investors.

Quantrom P2P Lending now has a track record of over three years, during which our investors have enjoyed a return of more than 28%.

With assets under management (AUM) of more than EUR 3 million, we have provisions of EUR 31,000 (approx. 1% of AUM), which are mainly related to two loan originators that stopped transferring funds. Actual losses amount to approx. EUR 3,000 (less than 0.1% of AUM).

A long-term investment horizon and the ability to avoid large losses is one of the most important drivers in investment management, and we hope that our long-term view and cautious approach have earned the trust of our investors.

 

About the Author

Gustav Jensen

Gustav is the managing director of Quantrom Limited and is living in near Brussels.

Economist from University of Copenhagen mainly working in finance and banking.