8

The Essential

Best Practices to Marketplace Lending Investing

Key Considerations for Institutional Investors & Investment Managers

By Jeremy Todd, Orchard Platform

INTRODUCTION

CONTENTS
Introduction

Marketplace Lending Investing Challenges

The Essential Eight Best Practices to

Introduction

Marketplace Lending Investing

I Alpha vs Beta Determination

II Direct Platform vs

Securitization Investing
III Leverage Utilization

15

IV Supply, Supply, Supply...

18

Finding, Accessing, Acquiring

V

Multi-platform Diversification

VI Portfolio Valuation
VII Portfolio Benchmarking
VIII Robust Infrastructure

22
24
27
30

Requirement
Investor Best Practices Checklist

36

Manager Best Practices Checklist

37

The purpose of this paper is to highlight

the challenges that institutional investors
and investment mangers face investing
in marketplace lending and offer a set
of best practices to assist both groups in
successfully investing in this new asset
class. To provide the greatest possible
benefit to both institutional investors
and managers, this paper will:
Highlight the 10 main challenges that institutional
investors and investment managers experience
investing in marketplace lending
Present a list of 8 essential best practices that can
help investors and managers

Provide an aggregated checklist of 25 overall

considerations for both investors and managers in
following the essential eight best practices
Orchard Platform

different supply acquisition process, require access to market data

significantly since it started in the U.S. in 2005

for credit modeling and require advance technological tools and

with Prosper Marketplace. To date, marketplace

different operational processes. Investors managing portfolios of

lending has originated over $12 billion in loans,

all sizes realize the challenges these differences present in order

but this amount is just the tip of the iceberg of

to efficiently invest in marketplace lending.

the multi-trillion potential market. 2014 saw many

milestones for the asset class: record originations,
rated securitizations and IPOs of two
marketplace lenders.
Many institutional investors have recently
discovered the marketplace lending asset class,
finding that it can offer highsingle digit or low
double digit returns, with short duration, low
expected volatility and consistent cash flow.

Offer a detailed sub-checklist within each

best practice

The marketplace lending industry has grown

Historically the investors purchasing these loans

were retail investors; institutional investors now

Because marketplace lending is so different from other

fixed-income strategies, institutional investors considering
a potential asset allocation to marketplace lending also
confront unique challenges in quantifying its benefits to
their portfolio. These challenges include understanding
how to benchmark a managers returns, recognizing
appropriate fees for alpha versus beta investment
strategies, and properly evaluating a managers
operational and technological infrastructure.
I first realized many of these peculiarities of
marketplace lending and the resulting challenges
they would present for institutional investors and

represent the majority of buyers investing in this

managers a couple years ago after I personally

asset class. The institutional shift has been the driver

started investing in marketplace lending.

of the name change from peer-to-peer lending, to

Having worked with hundreds of institutional

marketplace lending highlighting the fact that it

investors and investment managers over

is no longer individuals but institutions that are the

the years, it was quite apparent that the

predominant investors.

tools I used to invest my personal money

Marketplace lending loans differ from traditional

these investment managers to invest in

fixed-income instruments in several ways.

marketplace lending.

would not be sufficiently adequate for

Marketplace lending loans lack a strong secondary

market, have a smaller investable supply, have a

The Essential Eight Best Practices to Marketplace Lending Investing

3
2

INTRODUCTION

Although institutional investors now represent

by following best practices, they were able to get

the majority of investors in marketplace lending,

the necessary approvals from their investment

the $12 billion of marketplace lending assets is

committee and board of directors in order to make

still small compared to the $1 trillion plus market

an allocation to hedge funds.

that it could be. This dynamic reminded me of

the hedge fund industry almost twenty years ago.

This paper is meant to establish best practices for

I witnessed the hedge fund industry grow from

marketplace lending investing. We hope this content

having approximately $200 billion in industry

will provide institutional investors insight to properly

assets in 1997, when it was labeled mainly as two

understand and invest in marketplace lending

guys and Bloomberg, to $3 trillion in industry

and help investment managers implement the

assets today (15 times more) as a result of the

required infrastructure and operational processes

institutionalization of hedge funds.

to effectively get allocations from institutional

investors. These insights, considerations and best

Marketplace Lending
Investing Challenges
CHALLENGES FOR
INSTITUTIONAL INVESTORS

CHALLENGES FOR
INVESTMENT MANAGERS

1 Understand asset class characteristics

1 Credit modeling across multiple sub-asset classes

2 Determine alpha or beta allocation

2 Access to comprehensive data for analysis

3 Know different investing options

3 Invest with scale

for years. Once investment teams from pension

4 Analyze leverage utilization

4 Find and access to origination platforms

plans, endowments, foundations, sovereign wealth

5 Recognize importance of access to supply

5 Automate investing across originators

6 Mitigate counterparty risk

6 Accurate portfolio valuation

7 Verify portfolio valuation methodology

7 Portfolio benchmarking

8 Portfolio benchmarking

8 Robust technology infrastructure

9 Proper manager infrastructure evaluation

9 Portfolio management tools

10 Identify quality managers

10 Raise institutional capital

This institutionalization of hedge funds was

practices provided here is intended to address

driven by the adoption of a set of best practices

the challenges that both investors and managers

established for institutional investors so that they

confront in marketplace lending. We believe the

could get comfortable investing in hedge funds.

successful implementation of these eight essential

Investors concerns about managers using leverage

best practices in marketplace lending investing will

and shorting securities, paying performance fees,

allow for more rapid allocations of new institutional

operational robustness, and proper portfolio

capital to this asset class.

benchmarking hampered investments in hedge fund

funds and other institutions could implement a

thorough due diligence process on hedge funds

THIS PAPER IS MEANT TO ESTABLISH BEST PRACTICES FOR

MARKETPLACE LENDING INVESTING. WE HOPE THIS CONTENT
WILL PROVIDE INSTITUTIONAL INVESTORS INSIGHT TO PROPERLY
UNDERSTAND AND INVEST IN MARKETPLACE LENDING AND
HELP INVESTMENT MANAGERS IMPLEMENT THE REQUIRED
INFRASTRUCTURE AND OPERATIONAL PROCESSES TO EFFECTIVELY
GET ALLOCATIONS FROM INSTITUTIONAL INVESTORS.
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Orchard Platform

The Essential Eight Best Practices to Marketplace Lending Investing

MARKETPLACE LENDING INVESTING CHALLENGES

ALPHA VS BETA DETERMINATION

The Essential Eight Best Practices to

Marketplace Lending Investing
No

Alpha vs Beta Determination

Direct Platform vs Securitization Investing

Leverage Utilization
Supply, Supply, SupplyFinding,
Accessing, Acquiring
Multi-platform Diversification

Portfolio Valuation

Portfolio Benchmarking

Alpha vs Beta
Determination
One of the first decisions investors and managers must make
when deciding to invest in marketplace lending is whether to
employ an alpha or a beta investment strategy.

Robust Infrastructure
Requirement
Investor

$
Manager

Orchard Platform

The Essential Eight Best Practices to Marketplace Lending Investing

ALPHA VS BETA DETERMINATION

Investing in alpha strategies attempts to outperform

Active investing allows the manager to implement its own credit model. For

The obvious question is, why would a manager not always buy actively on an

an index. While, investing in beta strategies

example, a manager could select specific loans that they believe will have a lower

origination platform? One answer is that a manager may not have the option to

attempts to match the performance of an index.

expected default rate than the benchmark for loans originated on the platform,

invest actively on the origination platform; some platforms only permit passive

Both strategies can yield solid returns, but it is

therefore potentially generating alpha if those loans yield higher-than-expected

investing. Because of the high demand for marketplace lending loans, some

crucial that institutional investors understand the

returns.

originators find passive investing to be the most effective way of managing the

differences between them for many reasons including

Investor Checklist
Is the fund investing actively, passively,
or both?

distribution of their loan supply.

establishing proper investment benchmarks and

Passive investing allows the manager to purchase a pre-negotiated dollar amount

analyzing a managers fee structure. Generally,

of loans from the originator across the credit quality spectrum that the originator

Another factor that helps determine if a manager invests actively is whether

marketplace lending platforms,

investors are more willing to pay higher management

underwrites with few or no custom selection criteria. For example, the manager

the manager has their own credit model to actively select loans they believe

through securitized bonds, or both?

and performance fees for actively managed strategies

may decide they want to purchase $10 million per month in loans. In order to

will outperform the index. Most investment managers have a goal to generate

that they believe will generate alpha; investors expect

receive $10 million in loans from a specific originator, the manager may need to

alpha (as opposed to buying beta), but a manager would either need to create

to pay lower fees investing in passive index strategies

accept a group of loans ranging from an originators A prime paper (lowest-

their own credit model or utilize a third partys credit model to invest actively in

what type of credit model is the fund

in effect just buying beta. Yet the marketplace lending

yielding) to their lower-grade paper (highest-yielding). In this case, the investment

marketplace lending and may not have the know-how or desire to do so.

utilizing?

ecosystem has unique nuances that may impact a

manager is effectively purchasing an index of loans from the originator, and

managers ability to generate alpha. Institutional

hence, buying beta rather than trying to generate alpha.

asset class.
In marketplace lending, origination platforms can

select specific loans on the origination platform) or

Strategy

Institutional investors have the challenge of understanding whether they are

Outperformance
Possible?

Tools Needed

Customized
Portfolio

Yes
(Alpha possible)

Credit model

Another opportunity for investment managers to generate alpha in marketplace

Approval from originators to

actively select loans

lending is to buy securitized marketplace lending bonds, which is currently on the

properly benchmark performance, determine appropriate fees and evaluate

Will the originator allow me to purchase

marketplace lending managers.

loans actively?
Active

select specific loans on the origination platform).

rise. This leads us to our second best practice in marketplace lending investing.

Do I have my own credit model?

If not, is there a quality third-party

Passive

Orchard Platform

Does the credit model create alpha?

Manager Checklist

investing in an alpha generating strategy or a beta strategy, so that they can

Portfolio
Composition

passively (the manager does not have the ability to

8
7

The challenges for managers in deciding on an alpha strategy or a beta strategy

and securing sufficient supply from originators to be able to actively select loans.

ALPHA VS BETA DETERMINATION

offer loans for purchase to managers in one of

two ways: actively (the manager has the ability to

If the fund is investing actively, then

are building a successful credit model to identify alpha generating opportunities

investors must thoroughly understand these nuances

before contemplating an investment allocation to this

Is the fund investing directly on

Index

No
(Beta)

Negotiated supply from

originators

credit model I can use?

The Essential Eight Best Practices to Marketplace Lending Investing

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II

DIRECT PLATFORM VS SECURITIZATION INVESTING

No

II

Direct Platform
vs Securitization
Investing
The second best practice for investing in marketplace lending is
understanding the entire range of investment options available.
Unlike other fixed-income instruments such as government
bonds, corporate bonds or asset-backed securities, marketplace
lending loans for the most part, do not have an active secondary
market, with the exception of newly securitized marketplace
lending bonds (and fractional loans on certain originators only
available to retail investors).
Understanding the two main investment options in marketplace lendingdirect
platform versus securitization investingis very important for both investors and
managers to determine the best opportunities. There are a number of factors to
consider in analyzing these two options: transparency, portfolio customization,
yields, volatility, liquidity, shorting/hedging, leverage costs, and ease of investment.
Direct marketplace lending investing has the benefits of more transparency, a

Transparency

Portfolio Customization

Yields

The financial industry learned the

Direct platform investing allows managers

The securitization of a pool of

hard way the problem with not having

the full flexibility to customize their

marketplace lending loans into a

transparency when dealing in securitized

portfolios. Managers can create their own

bond is a complex process requiring

bonds. This lack of transparency allowed

credit model or use a third-party credit

the involvement of numerous parties

financial services companies to package

model, and be able to apply credit metrics

including lawyers, accountants, collateral

loans for distribution that had ratings that

that they believe will result in a lower

managers, placement agents, trustees and

did not accurately reflect the underlying

predicted default rate. In building a direct

administrators. Each of these participants

assets. With direct platform investing,

platform portfolio, investors can decide

receives fees from the securitization

investors have full transparency and know

the overall number of loans they wish to

process, resulting in a significant reduction

exactly which loans are in their portfolio

buy, the acceptable credit grade for those

in yield on the securitized bonds. For

along with hundreds of data points on

loans, and which subasset classessuch

example, Orchard recently completed

each loan. With marketplace lending

as consumer, small-business or real estate

an analysis of the yield of the BlackRock

securitized bonds, investors only have

loanstheyd like to invest in. By contrast,

securitization of Prosper Marketplace

basic metrics on the overall pool of loans,

a managers ability to customize a portfolio

loans. We found that an investor could

including weighted average borrower

of securitized marketplace lending bonds

expect to receive a yield of approximately

FICO scores, weighted average borrower

is limited to only deciding which tranches

7.32%more than double the bonds

interest rates and weighted average

to buy.

weighted average yield of 3.58% on the A

durations.

and B tranchesby investing directly in

these loans.

higher level of portfolio customization, potentially higher portfolio yields and less
volatility compared to securitized marketplace lending bonds. On the other hand,
securitized marketplace lending bonds offer greater liquidity, lower leverage costs
and an easier way to purchase assets.

Orchard Platform

The Essential Eight Best Practices to Marketplace Lending Investing

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II

DIRECT PLATFORM VS SECURITIZATION INVESTING

Volatility

Liquidity

Shorting/Hedging

Leverage Costs

Ease of Investment

Direct platform loans are not available to be re-

Securitized bonds are considered to be more liquid, since there is an actively

Many alternative investment managers,

Generally, the cost to finance a securitized

Typically, investment managers can

sold or easily traded making them less volatile. A

traded secondary market for them. Loans purchased directly through origination

such as hedge funds, want the ability

bond is lower compared to the cost to

easily purchase and hold securitized

marketplace lending loan is sold at face (or par)

platforms cannot be easily re-sold because they do not have an actively traded

to short a bond they perceive as being

finance a direct marketplace lending

marketplace lending bonds using their

value and the value of the loan will not be easily

secondary market are considered relatively illiquid. There are multiple, obvious

overvalued, an opportunity that does

portfolio. This is a result of multiple factors

existing operational infrastructure. By

affected by supply and demand since there is no

advantages in having liquidity in any financial instrument, including the ability

not currently exist in direct platform

that will be explained when we turn to the

comparison, investing in marketplace loans

secondary market to value the loan. The benefits

to easily reduce or increase market exposure by purchasing or selling a security

investing. However investment managers

next best practice, leverage utilization.

directly through an origination platform

of not having volatility in direct platform loans are

and the ability to generate alpha by purchasing securities the investor perceives as

do have the ability to short a securitized

requires managers to have an additional

that the loans will not be influenced by external

being underpriced.

marketplace lending bond, which affords

operational infrastructure to efficiently

managers the potential to create alpha by

manage, analyze, acquire and report on the

default risk. On the other hand, securitized bonds

An understanding of the listed term of a loan with direct platform investing

shorting a bond. Shorting marketplace

individual loans in their portfolios.

can be traded on a secondary market and the value

versus the actual duration of the loan is key for investors in analyzing and

lending bonds also lets these managers

of the bonds can fluctuate based on market prices

understanding liquidity concerns within the subasset classes of marketplace

hedge their portfolios by reducing their

determined by supply and demand of the secondary

lending. For example, although the listed term of a consumer loan is generally

overall market exposure.

market. Therefore, securitized bonds can be traded

36 or 60 months, once pre-payments are factored in, the actual duration is

more actively and will likely trade at a premium or

closer to 18 months or 30 months, respectively. Other subasset classes, such as

discount to the par value of the bond resulting in

small-business loans, have even shorter actual durations. A more comprehensive

volatility of the bond.

understanding of durations can greatly help investors assess the overall liquidity

market factors like interest rates, inflation rates and

profile of their direct marketplace lending investments.

DIRECT MARKETPLACE LENDING INVESTING HAS THE BENEFITS

OF MORE TRANSPARENCY, A HIGHER LEVEL OF PORTFOLIO
CUSTOMIZATION, POTENTIALLY HIGHER PORTFOLIO YIELDS AND
LESS VOLATILITY COMPARED TO SECURITIZED MARKETPLACE
LENDING BONDS.

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The Essential Eight Best Practices to Marketplace Lending Investing

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II

Financial industry vs marketplace lending distribution flow

DIRECT PLATFORM VS SECURITIZATION INVESTING

In summary, both direct platform investing and securitized bonds investing have
advantages and disadvantages, depending on the managers goals. There are

TYPICAL FINANCIAL INDUSTRY DISTRIBUTION FLOW

Investor Checklist

Allocators

many considerations including risk/return objectives, liquidity requirements, and

leverage utilization that will help guide managers toward a tailored methodology
for investing in the marketplace lending asset class. The best solution for some

What level of transparency is required in

my investment strategy?

managers might be a combination of both direct platform investing and

securitized bonds depending upon the requirements of institutional investors

What level of customization do I require

within and across subasset classes?
Am I willing to extend my investment

Consideration

Direct Platform Investing

Securitized Bonds

terms with a manager in exchange for

potentially higher returns and lower

Transparency

More

Less

Portfolio
Customization

Yes

No

Yields

Higher

Lower

Volatility

Minimal

Higher

Liquidity

No

Yes

Institutional Investors
Pensions
Endowments
Foundations
Sovereign Funds
Insurance
Family Offices
Banks
Fund of Funds

$
Invests
$
Redeems

Distributors
Managers
Hedge
Funds
BDCs
Asset
Managers
RIAs
Wealth
Managers

$
Cash

Securities

Securities

volatility?
MARKETPLACE LENDING ASSET CLASS DISTRIBUTION FLOW (NOT INCLUDING SECURITIZATIONS)

Leverage Costs
Ease of Investment

Higher
New infrastructure required

Lower
Use existing
infrastructure

Distributors

Borrowers

Manager Checklist
How do I best construct my

Individual Investors

marketplace-lending portfolio to

Possible

Corporations
Debt
Offerings

Offering
Proceeds

Individual Investors
High Net Worth

Institutional Investors

Not possible

Broker
Dealers

Allocators

Shorting/Hedging

Borrowers

Managers

Originators
Consumer
Small Business
Real Estate
Education
Auto
Medical
Solar
Receivables
Commercial
Equipment

Invests

Cash

properly address my objectives?

Redeems

Which investing options best satisfy the

Principal
& Interest

Cash

liquidity terms of my investors?

$
$

Do I plan to use leverage and/or hedge

$
Principal

Borrowers
Individuals
Businesses

$
Principal
& Interest

Principal & Interest

my portfolio?

MARKETPLACE LENDING ASSET CLASS DISTRIBUTION FLOW INCLUDING BROKER DEALER SECURITIZATIONS
Allocators
Institutional Investors
Individual Investors

Distributors
Managers

$
Cash

Invests

Broker
Dealers

Cash

Principal

Loans

Principal
& Interest

$
Redeems

Originators

Borrowers
Borrowers

$
Invests
Cash

Securities

$
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The Essential Eight Best Practices to Marketplace Lending Investing

Securities

15
14

III

LEVERAGE UTILIZATION

The third best practice to consider in marketplace lending

investing is leverage utilization. Leverage utilization
considerations include whether the manager is currently
using leverage as part of their strategy, how much leverage
the manager is using, and whether the manager is minimizing
their cost of leverage within the fund.

agencies at either the investment-grade or high-yield level. The high ratings,

liquidity profile and diversification of the bonds in an overall portfolio have
allowed banks to lend at rates ranging from 0.60% to 1.25%. Additionally,
dozens of banks are now willing to provide financing on securitized marketplace
lending bonds because they are comfortable with the risk profile of the asset class.
Banks typically provide leverage on these bonds through repo lines or in a margin
lending account.
Even though direct marketplace lending loans are often diversified, the loans are
not rated by the credit agencies and are not very liquid. Accordingly, banks are

Leverage Utilization
No

III

Knowing the answers to these questions will help

on an origination platform. The cost of leverage on

institutional investors analyze and benchmark a

a fixed-income portfolio typically depends on the

managers returns better. For managers who are

ratings of individual bonds, the liquidity of bonds,

conscientiously addressing investor concerns around

and the diversification of the bonds in the portfolio.

leverage utilization, this can potentially help them

Leverage providers such as banks offer different risk

offer a better and differentiated product to investors

methodologies to determine the appropriate margin

by generating additional alpha while minimizing

relief (i.e., leverage ratio) that they are willing to

financing costs.

extend for a bond portfolio. Some providers may

15

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TREND

others may require margin on the overall portfolio

volatility, investment managers are increasingly

the overall risk/return profile of fund managers that

of bonds. A portfolio of higher-rated bonds, that

allocating a small percentage of their portfolio to direct

utilize leverage in their portfolios. Managers can

are more liquid and more diversified will result in

marketplace lending investments. Most are currently

employ many different methods for leverage in their

a lower risk profile, which potentially means both a

borrowing capital at a cost of less than 1% and investing

fixed-income portfolios, including margin lending,

lower cost of leverage financing and a lower margin

these funds at an expected return of 8% or higher. The

repurchase agreements (repo), options, futures, swaps

requirementgiving investors an opportunity to gain

liquidity risk of direct marketplace-lending investment

and lines of credit. As previously mentioned, the cost

additional leverage.

is greatly minimized in this scenario, since the manager

has plenty of liquidity in the rest of their portfolio to

of loans purchased through direct platform investing

bonds have received ratings by the major credit

a bank to receive leverage on direct marketplace lending loans and the current
interest rate for such a facility is usually around 4%. Additionally, the borrowing
terms for receiving such a facility are extensive, covering areas such as facility
amount, term, price, unused-line fees, commitment fees, advance rates, collateral
triggers, financial covenants and collateral covenants. Nonetheless, we are starting
to see the borrowing costs on these credit facilities decrease as banks develop

Investment managers that only directly invest in marketplace lending on origination

Institutional investors are usually adept at analyzing

The recent securitizations of marketplace lending

time, an investment manager will have to establish a line of credit facility with

are now offering credit facilities to managers.

In order to increase portfolio returns while reducing

generally lower than the cost to leverage a portfolio

on these investments, which is very different from securitized bonds. Most of the

increased comfort with the risk profile of direct platform loans, and more banks

require margin on an individual bond basis, and

to finance securitized marketplace lending bonds is

not able to provide financing at aggressive rates and low margin requirements

satisfy any potential investor redemption requests.

platforms are largely restricted to credit facilities as a leverage option, since

most banks are not currently providing margin loans and repo lines as leverage
options on these investments. Managers that utilize leverage and hold securitized

Asset Class

Approximate Current Cost of

Leverage Financing

Direct Platform Marketplace Lending

3% to 4%

Equities (Cash & Swap)

0.35% to 0.65%

Investment-Grade Corporate Bonds

0.60% to 0.75%

High-Yield Corporate Bonds

0.75% to 1.10%

Unrated Corporate Bonds

1.5% to 2%

The Essential Eight Best Practices to Marketplace Lending Investing

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III

IV

LEVERAGE UTILIZATION

Risk Consideration

Direct Platform
Marketplace Lending

Securitized Bonds

Ratings

No

Yes
(Several are rated)

Liquidity

No

Yes

Diversification

Yes

Yes (Bond consists

of thousands of
underlying notes)

marketplace lending bonds should leverage those bonds to receive a lower cost of
financing. Managers that invest in marketplace lending assets as part of a portfolio
that also hold other asset classes should leverage their more liquid assets that have a
lower cost of financing to minimize the overall financing cost for the portfolio. For
example, suppose a manager would like to borrow $50 million on a $500 million
portfolio. If the manager can borrow $50 million using equity stocks as collateral
and pay an interest rate of 0.5% rather than using unrated bonds as collateral and
pay an interest rate of 2%, the manager should leverage their equity collateral to
lower the cost of borrowing.
Properly understanding leverage utilization for marketplace lending assets is
necessary to help both institutional investors and investment managers enhance
their returns while minimizing costs.

SUPPLY, SUPPLY, SUPPLY . . . FINDING, ACCESSING, ACQUIRING

No

IV

The old adage that the three most

important things in real estate are
location, location, location can be
similarly applied to marketplace lending.
The most important things in marketplace
lending are supply, supply, supply.

Supply, Supply, Supply . . .

Finding, Accessing,
Acquiring
That is, in marketplace lending you first have to find supply, then you have to
be able to access the pool of supply, and lastly you have to be able to acquire
specific loans from the pool of supply. Although this sounds simple enough,
the process can be anything but straightforward. As a result, Supply, Supply,
Supply . . . Finding, Accessing and Acquiring is a necessary best practice within

Investor Checklist
How much leverage does the fund
utilize, if any?

Manager Checklist
Should I utilize leverage in my
marketplace lending strategy?

marketplace lending.
Investors performing due diligence on marketplace lending investment managers
must be able to answer the following questions about the manager: Which
originators does the manager have access to? If an originator offers multiple

What is the cost of the funds leverage?

How do I obtain leverage on

marketplace-lending assets?

Is the fund appropriately minimizing the

cost of leverage where possible?

How do I minimize my leverage

financing costs?

products, which subasset classes does the manager have access to through each
originator? Is the originators supply allocation method uniformly passive, or does
the manager have the ability to buy actively?
Managers need to be able to locate the right types of supply for their strategy,
negotiate terms with originators for accessing supply and implement the needed
infrastructure to acquire the supply.

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IV

SUPPLY, SUPPLY, SUPPLYFINDING, ACCESSING, ACQUIRING

Finding Supply
Both investors and managers need to have a clear
understanding of current market dynamics in
order to address these challenges. Today, demand
for marketplace loans from originators exceeds the
available supply. This enables most originators to be
selective on which institutional (non-retail) clients
they want to offer supply, how much they offer, and
how they offer itpassive or active selection. This
market bias in favor of the originators can make it
challenging for managers to acquire marketplace
lending loans. Therefore, finding supply is critical
for investment managers that are trying to pursue
a successful alpha generating marketplace lending
strategy. Managers primarily find supply in one
of two ways: they can contact platforms directly
and request access to supply or they can reach out
to a third party with a strategic relationship to the

Although originators have the advantage in

Many of the newer originators are looking to establish strategic

determining how much and what kind of supply

relationships with third parties to help them distribute their supply

they offer and to whom they offer it to, they still

of loans efficiently. This helps the originator save resources in the

want and need to ensure they allocate their supply

process of locating the right customers for their limited supply.

strategically in order to facilitate the tactical

Managers that fully understand the landscape of originators and

growth of their firms. Originators must consider

their third-party relationships can gain access to multiple new

several variables in these allocation decisions:

suppliers offering various subasset classes that likely would fit

how much supply a manager wants to purchase,

their funds investment goals and parameters.

what grade level of loans the manager wants to

purchase, whether the manager wants to purchase
loans actively or passively, and whether there are
other strategic benefits in allocating supply to the
manager. Examples of these other strategic benefits
might be if the manager is willing to purchase
a new subasset class the originator is starting
to underwrite, or is willing to make an equity
investment in the origination platform in exchange
for desired supply.

Accessing Supply
Once an investment manager finds an originator they
would like to purchase loans from, the manager must then
negotiate the terms of purchase of the supply and sign a
loan purchase agreement to formalize the relationship.
The loan purchase agreement specifies the agreed-upon
terms discussed earlier in this paper: how much supply
the manager can purchase, the types of loans available

FOR MANAGERS, UNDERSTANDING

ALL THE CHALLENGES OF
FINDING, ACCESSING, AND
ACQUIRING MARKETPLACE LOAN
SUPPLY IS KEY TO THE SUCCESSFUL
IMPLEMENTATION AND SCALING
OF THEIR MARKETPLACE LENDING
INVESTMENTS.

to be purchased (credit grade, duration, etc.), whether

originator to facilitate an introduction.

the investment will be active or passive, and, if

applicable, possible securitization terms. Investment
managers typically spend considerable legal
resources negotiating mountains of documentation

Finding Supply

Accessing Supply

Acquiring Supply

with counterparties for a given deal. Investment

managers should anticipate allocating considerable

Goal

Identify originators whose products

Negotiate terms and loan purchase

Purchase loans actively and/or

fit managers strategy.

agreements with originators.

passively.

legal resources in negotiating documentation with

marketplace lending originators. This high level
of resource consumption makes it all the more
essential that managers partner with the right

Challenge

Solution

19

Partner with enough originators to

Access sufficient legal resources to

Establish effective operational

originators, to ensure they can appropriately

scale investments.

negotiate with multiple originators.

infrastructure for active loan buying.

scale their investment in marketplace lending.

Hire internal resources or partner

Use internal legal resources or

Invest in multiple proprietary

with third-party firm.

outsource to experienced third-

trading connections or install order

party lawyers.

management system.

Orchard Platform

The Essential Eight Best Practices to Marketplace Lending Investing

21
20

IV

SUPPLY, SUPPLY, SUPPLYFINDING, ACCESSING, ACQUIRING

MULTI-PLATFORM DIVERSIFICATION

Investor Checklist
INVESTMENT MANAGERS SHOULD ANTICIPATE
ALLOCATING CONSIDERABLE LEGAL RESOURCES

From which originators does the

manager have access to purchase loans?

IN NEGOTIATING DOCUMENTATION WITH

MARKETPLACE LENDING ORIGINATORS.

Which subasset classes does the

manager purchase, and from which
originators?

No

Multi-platform
Diversification

Is the originators supply allocation

Acquiring Supply

active or passive?

As described earlier, managers can purchase loans either actively or passively

from originators. The process of acquiring loans passively is fairly straightforward,
as the originator will simply allocate a pool of loans to the manager according
to the terms of the loan purchase agreement. The originator will provide the
investment manager with a report stating which loans were allocated to the
manager. The process of acquiring loans actively is much more complex. In active
loan investing, a manager may be competing with hundreds of other buyers to
acquire the same loan. Originators typically release loans at set times throughout
the day for purchase and many loans are sold within milliseconds of their release.
This means that it is imperative that investment managers have the technological
infrastructure to quickly identify which available loans fit the managers credit
model and be able to purchase these loans quick enough before another investor
does. Without the right tools, the manager likely will not have the ability to actually
deploy capital. The second critical challenge for investment managers that are
actively investing in marketplace lending loans is understanding how to effectively
implement this purchasing ability across multiple originators. Potential solutions
for active purchasing will be addressed in the eighth best practice, regarding robust
infrastructure requirements.
For managers, understanding all the challenges of finding, accessing and acquiring
marketplace loan supply is key to the successful implementation and scaling of their
marketplace lending investments. On the other side of the table, an institutional
investor must understand which originators a manager has purchase agreements
with, which subasset classes the manager can access through those originators and
whether the manager will be investing actively or passively in each case.

21

Orchard Platform

Manager Checklist
How much supply do I need access to
across the subasset classes?
How many different originator
relationships do I need to secure a
sufficient and desirable loan supply?
How best do I allocate my legal

The fifth essential best practice in marketplace investing

is multi-platform diversification. This means that it is
prudent for both institutional investors and investment
managers to diversify their marketplace lending
investments across multiple originators. The importance
of evaluating counterparty risk exposure and having
enough counterparties was made clear by the financial
industry collapse of 2008.

resources to negotiate the loan purchase

agreements?

Some money managers who had the misfortune of having their assets caught up in
their banks bankruptcy liquidation proceedings have only recently had these assets

What infrastructure do I need to acquire

the loans from the supply to which I have
access?

returned after years of not being able to access their assets.

Prior to 2008, counterparty risk exposure was not even among the average top
ten criteria that investment managers used in selecting a bank to take custody of
assets and/or provide leverage to their portfolio. It should not be surprising that for
several years after 2008, counterparty risk exposure was the number one criteria for
fund managers in choosing a prime broker (bank custodian). In addition, managers
became diligent about diversifying their counterparty risk exposure by having
multiple prime brokers hold only portions of their overall assets. In the event that a
prime broker became insolvent, the fund manager would be protected to only lose
access to a portion of their assets rather than all their assets.
The Essential Eight Best Practices to Marketplace Lending Investing

22

VI

MULTI-PLATFORM DIVERSIFICATION

To this day, investment managers expend considerable effort minimizing

counterparty risk through their execution, financing and custodian relationships.

PORTFOLIO VALUATION

Investor Checklist

Managers conduct their risk analysis using a variety of tools: extensive due
diligence questionnaires, SAS 70 Type II reports, a firms credit ratings, a firms

What is the investment managers

credit default swap price, limitations on a counterpartys ability to rehypothecate

due-diligence process for analyzing

assets, limitations on cross-default rights within their accounts and more.

counterparty risk with originators?

Similarly, investment managers must also address counterparty risk exposure

multiple originators to help mitigate

due diligence on originators from whom they wish to purchase loans from and

counterparty risk?

allocating assets across multiple originators to diversify their counterparty risk. An

investment managers due diligence on originators should include understanding
back-up loan servicing agreement in place in the event the originator becomes
insolvent, verifying the operational robustness of the originators infrastructure
and other similar safeguards.

bankrupt is widely perceived as being low, managers and investors should not forget
the lessons learned from 2008. Institutional investors should require investment
managers conduct proper due diligence on originators from whom they purchase
loans and also require managers partner with multiple originators to diversify their
counterparty risk. Likewise, managers have a fiduciary responsibility to protect
investors capital by properly addressing counterparty risk.

Risk

Description

Counterparty
Risk

23

Potential loss of invested

assets resulting from
bankruptcy of marketplace
lending originator

Orchard Platform

Manager Checklist
Does the originator pass my
due-diligence analysis regarding

Although the risk that any of the top marketplace lending originators would go

Solutions
 Conduct proper due diligence
on originators safety and
soundness
 Purchase marketplacelending loans across multiple
originators, including within
each subasset class

In todays regulatory
environment, proper
portfolio valuation
that emphasizes good
governance and
independent verification is
even more important for
institutional investors.

VI

Does the manager invest with

with their marketplace lending investments. This entails both conducting proper

an originators bankruptcy remote structure, ensuring the originator has a

No

counterparty risk?

Portfolio
Valuation

Am I properly diversified across

multiple originators to mitigate my
counterparty-risk exposure?

Investors are requiring managers to implement

properly valuing a marketplace lending portfolio

valuation processes with these improved guidelines.

can be complex, as described in the sidebar on the

Properly valuing a portfolio entails assessing the

next page. A funds valuation methodology needs

portfolios performance, which in turn determines

to address these specific challenges in order to

the management fees and performance fees that

appropriately analyze performance on a marketplace

managers charge their investors. An institutional

lending portfolio.

investor should try to fully understand and be

comfortable with a managers portfolio valuation

As highlighted in the second best practice, Direct

process before any potential allocation is made to

Platform versus Securitization Investing, a security

the manager. Investors should also require that

that trades on a secondary market is relatively

the manager have an objective and documented

easy to value properly, since such a valuation can

valuation process performed by an experienced,

be based on the last trading price of the security.

reputable and independent third party. For

Since non-securitized marketplace lending assets

managers, it is therefore imperative to implement a

are not traded on a secondary market, the portfolio

process performed by a third-party firm. However,

valuation methodology requires pricing every single

The Essential Eight Best Practices to Marketplace Lending Investing

24

VI

PORTFOLIO VALUATION

loan in a funds portfolio based upon the loans current expected default rate.
Most managers have thousands of loans in their portfolios across multiple
originators and subasset classes. Consequently, pricing each and every

MARKETPLACE LENDING
PORTFOLIO VALUATION
CHALLENGES

loan correctly can be a daunting process. It helps to understand the main

considerations involved in properly valuing each loan.
One of the most important considerations in marketplace lending portfolio
valuation is accurately accounting for loans that are not current. A current

Most marketplace lending assets do not

trade on an exchange, making real-time
price discovery more difficult

Expected defaults rates on originator

platforms change frequently

loan is considered a loan that the borrower has made all the required
payments to date according to the specific terms of the loan; a non-current

PROPERLY VALUING A PORTFOLIO

ENTAILS ASSESSING THE PORTFOLIOS
PERFORMANCE, WHICH IN TURN
DETERMINES THE MANAGEMENT
FEES AND PERFORMANCE FEES THAT
MANAGERS CHARGE THEIR INVESTORS.

loan is considered a loan that the borrower is failing to fully satisfy the terms

report to a third-party valuation firm to

have not yet developed the reporting tools needed by a third-party firm

perform a proper valuation analysis?

therefore the value of the loan may become zero (written off). The expected

for proper valuation.

default rate of a loan increases as the loan becomes further past due; this

and economic conditions that will also impact the expected default rate of

standardized, a data file can be provided to the third-party valuation

a loan over time. For example, the expected default rate for a loan that was

company to complete an efficient portfolio valuation. Typically, investors

more than 30 days past due was likely different at the end of 2014 compared

prefer another third party aggregate, standardize, and send this data file

to the beginning of 2014 across subasset classes and across originators.

without the ability of the manager to manipulate the data. In this way,

Proper portfolio valuation will need to account for these changes over time.

not only will the funds portfolio valuation be more efficient but also its

Fortunately, many originators provide good statistical data on their loans and

investors will have greater confidence knowing that the manager has

offer adjusted loan values for non-current loans. Moreover, some originators

an appropriate and adequately safeguarded portfolio valuation process.

even provide an adjusted net annualized return calculation that accounts for

This methodology helps assure institutional investors that the manager is

these valuation modifications to non-current loans.

properly calculating the performance of the portfolio and consequently

Standardizing data aggregated from

multiple originators is complex

portfolio valuation?

reflect the increased likelihood that this loan may ultimately not be repaid and

subasset class

independent third-party firm for

aggregated and standardized data

managers entire portfolio. Once the portfolio data is aggregated and

subasset classes

Does the fund use a reputable and

formats from different originators. Furthermore, many new originators

A proper valuation methodology must also account for the changing market

Expected default rates differ across

documented valuation process?

default. A non-current loan needs to be appropriately reduced in value to

A much more efficient and better strategy for the investment manager

originators may differ within the same

Does the fund have an objective and

Does the fund provide an independently

of the loan and has therefore been deemed in a grace period, late, or in

higher expected default rate over time in turn reduces the value of the loan.

Expected default rates across multiple

Investor Checklist

is to have the capability to aggregate data and standardize it across the

charging the correct management and performance fees. The last

A third-party valuation provider will require access to a managers portfolio

important benefit of having proper portfolio valuation is the ability to

in order to complete the valuation process. Yet it can be very difficult for the

then perform portfolio benchmarking, which leads us into our seventh

third-party firm to gain access to the necessary data, which comprises of the

best practice

Manager Checklist
Is my portfolio valuation process
objective and documented?
Which third-party company should
perform my portfolio valuations?
Which third-party company can
independently provide the valuation
company with an aggregated and
standardized data report to perform a
proper valuation analysis?

aggregated data across all the originators from whom the manager purchases
loans supported into a standardized format that the valuation provider can
use. It is the fund managers responsibility to ensure this data is available to the
valuation firm. Many funds are able to request that a data file be sent directly
from an originator to the valuation firm, but the valuation firms job becomes
more challenging when they must evaluate data from multiple files in multiple

26

Orchard Platform

25

Orchard Platform

The Essential Eight Best Practices to Marketplace Lending Investing

26

VII

PORTFOLIO BENCHMARKING

No

VII

Portfolio Benchmarking
The seventh best practice in marketplace lending investing
is portfolio benchmarking. Portfolio benchmarking is critical
for institutional investors, enabling them to determine if and
how alpha is being generated in a fund managers portfolio.
Proper benchmarking is necessary for the investor to determine
whether or not they want to make an asset allocation to a
manager, and if so, on what terms.
The two levels of portfolio benchmarking available

own portfolio composition. For example, an equity

for marketplace lending strategies are:

manager who has a fund that only invests in largecap U.S. equity stocks should be utilizing the S&P

1) Comparing overall portfolio returns against

500 index as their benchmark; they should not use

a public marketplace lending index (this

a fixed-income index as their benchmark because

benchmarking does not use portfolio attribution),

those are two separate asset classes with completely

2) Comparing portfolio returns against a customized

benchmark (this benchmarking does use portfolio
attribution).
The first, easier level of portfolio benchmarking is
simply to compare a portfolios overall performance
against a publicly available index. The main rule
of thumb for benchmarking a funds performance
against an index is that the index used must be
the index that most closely resembles the funds

27

Orchard Platform

different characteristics. Similarly, a marketplace

lending fund that is generally comprised of shortduration, high-yield loans should not be using the
S&P 500 index as a benchmark for similar reasons.
The Orchard U.S. Consumer Marketplace Lending
Index is available for performance comparison and
benchmarking of marketplace lending strategies.
The second level of portfolio benchmarking entails
comparing portfolio returns to a customized
benchmark using portfolio attribution. Such a

customized benchmark should account for the

The cumulative total from each of these category

three following attributes of each loan: 1) vintage,

outputs would represent total alpha generated by

2) grade, and 3) term. Vintage can be defined

the manager on investments with that originator. To

as when the loan was originated. Benchmarking

benchmark a complete portfolio, the same analysis

loans by vintage helps investors compare the

would need to be done for each originator, and then

performance of the managers portfolio to that of

portfolio-weighted across all originators to determine

loans issued during a similar time period and having

the overall portfolio alpha generation.

experienced a similar level of seasoning. Grade can

be defined as the specific credit rating that each

Failure to account for loan vintages, grades, and

originator assigns to each loan that went through

terms in portfolio attribution will very likely

an underwriting process. Benchmarking loan

significantly skew a funds performance numbers

grades is critical to ensure an accurate comparison

when benchmarking a managers portfolio. A

of the managers portfolio risk level versus the

manager therefore needs the right tools in order

benchmark risk level. Term is defined as the length

to access, analyze, and report on vintage, grade,

of the loan (the amount of time the borrower has

and term factors for accurate benchmarking.

to pay back all of the principal and interest). For

Institutional investors should require this detailed

example, consumer loan terms are usually either 36

attribution analysis report from active managers to

or 60 months. Benchmarking the term of loans is

demonstrate alpha

important because longer-term loans with the same

grade rating, as compared with shorter-term loans,
usually have a higher interest rate to account for

Factor

Factor Definition

Importance of using factor in comparing fund

vs. benchmark

Vintage

Date loan was

Provides accurate comparison of default rates over

originated

similar time horizon

Risk rating of loan

Enables accurate comparison of loans with same

assigned by originator

risk level

Length of the loan

Accounts for the higher interest rates resulting from

their higher expected default risk.

To properly benchmark a marketplace lending
portfolio, a manager would need to compare their
funds performance within each applicable category

Grade

against the originators performance within the same

category. The performance comparison within each
category would highlight any alpha the manager
succeeded in generating within that category.

Term

higher expected default rates on longer term loans

with same risk grades as shorter term loans

The Essential Eight Best Practices to Marketplace Lending Investing

28

VII

VIII

PORTFOLIO BENCHMARKING

Investor Checklist

Am I benchmarking my fund against the appropriate

appropriate marketplace-lending index/es?

marketplace-lending index/es?

Is the manager capable of providing a detailed portfolio

Am I able to offer a detailed portfolio attribution

attribution report, highlighting alpha generation?

report to investors, highlighting alpha generation?

How is the manager performing versus the

How am I performing versus the established

established benchmark/s?

benchmark/s?

Orchard US Consumer
Marketplace Lending Index

No

The Orchard US Consumer Marketplace Lending Index (the Index) is designed

to measure the performance of direct online lending to US consumers. The Index
tracks the performance of the aggregate amount of loans to consumers originated
and funded on eligible US-based online lending platforms.

1400

MONTH-TO-DATE

0.63%

1350

12-MONTH RETURN

9.34%

Robust

Infrastructure Requirement
nine types of risk are: 1) minimal technology

invest in their firms infrastructure to more efficiently

infrastructure, 2) disparate technology infrastructure,

1250

manage their own portfolio and reduce potential firm

3) insufficient tools for credit modeling, 4) execution,

1200

and fund risks. Institutional investors enforce this

5) counterparty, 6) inadequate portfolio management

1150

robust infrastructure requirement because they need

reporting, 7) inaccurate portfolio valuation, 8)

to ensure that both their assets are safe and that they

insufficient performance reporting, and 9) disaster

have a good probability of receiving the expected

recovery. These operational risks generally apply

investment returns.

to other asset classes, but are more pronounced in

3-MONTH RETURN

1.98%

VIII

Hence, money managers will need to thoughtfully

1300

1100
1050
Q1
12

Q2
12

Q3
12

Q4
12

Q1
13

Q2
13

Q3
13

Q4
13

Q1
14

Q2
14

Q3
14

Q4
14

Orchard Index

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

YTD

2014

0.65%

0.64%

0.64%

0.79%

0.72%

0.71%

0.71%

0.71%

0.73%

0.63%

0.71%

0.63%

8.57%

2013

0.54%

0.51%

0.62%

0.62%

0.61%

0.63%

0.67%

0.70%

0.66%

0.67%

0.60%

0.71%

7.82%

2012

0.49%

0.46%

0.51%

0.56%

0.61%

0.59%

0.52%

0.51%

0.53%

0.57%

0.55%

0.55%

6.65%

Orchard Platform

The eighth and final best practice in marketplace lending

investing is having a robust infrastructure. Numerous studies have
highlighted the fact that up to 50% of the criteria an investment
manager must satisfy to receive an asset allocation from an
institutional investor pertains to having a robust infrastructure.

Manager Checklist

Does the fund benchmark itself against the

29

ROBUST INFRASTRUCTURE REQUIREMENT

the marketplace lending ecosystem because of the

What qualifies as a robust infrastructure to support

nuances of the asset class. Below are the needed

a marketplace lending strategy? Managers must

infrastructure solutions to properly address each core

account for nine core operational risks in establishing

operational risk:

their infrastructure for marketplace lending. These

The Essential Eight Best Practices to Marketplace Lending Investing

30

VIII

ROBUST INFRASTRUCTURE REQUIREMENT

Manager Operational Risks

across multiple originatorscan quickly

investor confidence. The manager should

become complex, problematic and

work to minimize the number of different

strenuous. Hence, a manager needs to

technology systems are being used,

implement a comprehensive technological

providing for better efficiency

and reliability.

Risk Type

Description

Infrastructure Requirement

Minimal technology
infrastructure

Managing most or entire fund infrastructure

on spreadsheets

Implement technological infrastructure that is comprehensive and fully integrated

across multiple functionalities including execution, reporting, analysis, and data
management

infrastructure that is nimble across multiple

not able to acquire the right loans to

implement their custom credit model.

3 I nsufficient Tools For

Credit Modeling Risk

Disparate technology
infrastructure

Implementing too many technology tools that do

not work together efficiently

Minimize number of different technology platforms utilized, providing for better

compatibility, efficiency, and reliability

for their marketplace lending portfolio and

Insufficient tools for

credit modeling

Not having current and historical originator data

and tools for analyzing data to generate alpha

Gain comprehensive access to data from all originators and buy or build
technological tools to analyze loans; create and back-test credit models

will expect such an infrastructure in order

Investment managers thrive on data in

to make an allocation to the manager.

order to manage their portfolios. Regardless

Execution

Counterparty

Not being able to acquire desired loans for active

investment strategies
Only using one originator to invest all fund
assets

Inadequate portfolio
Not being able to easily import, export,
management reporting aggregate, analyze, store, and graphically report
data regarding entire portfolio

this new asset class. Institutional investors

of the asset class theyre researching,

Buy or build order-management system that can acquire loans with needed speed

Utilize one order-management system to efficiently acquire loans across multiple

originators
Buy or build customized portfolio management reporting system that can
aggregate and manipulate data from all originators in a standardized format

2 D
 isparate Technology
Infrastructure Risk

they want access to both historical and

current data to make informed investment
decisions. As a result, managers need tools

A disparate technology infrastructure is

to receive, analyze, and create models,

a result of having multiple technology

charts, and other assessments from this

systems in place that do not work well

data. Similarly, marketplace lending

together. Having a disparate technology

managers want current and historical data

Inaccurate portfolio
valuation

Not properly valuing portfolio and consequently

overcharging investors

Utilize portfolio management system that securely provides standardized

aggregate data to a third-party valuation firm

infrastructure is almost as problematic

to perform proper credit analysis on each

as having a minimal technology

originator from whom they are considering

Insufficient portfolio
benchmarking

Not being able to clearly illustrate investment

return/manager value to investors

Access and ability to aggregate, analyze, and report both manager portfolio and
originator index data for portfolio attribution

infrastructureif your technology

purchasing loans. In order to perform

infrastructure is incapable of feeding

proper credit analysis in marketplace

data to another internal system, then a

lending, managers need tools similar

manager will most likely spend a great

to those used in traditional asset classes

deal of time manually transferring data

to analyze loans, but such tools are not

from one system to another system,

widely available for marketplace lending.

which can be inefficient. For example,

Therefore, managers have to either identify

suppose a manager is using a marketplace

third party modeling tools or create the

lending order management system to buy

right internal modeling tools to perform

loans across multiple originators. The

comprehensive credit analysis. Since

order management system then must be

investors need to understand a managers

able exchange information with other

research process, institutional investors will

third-party systems, such as a portfolio

require that managers describe in detail

management system. Compatibility

their credit-analysis methodology, including

creates operational efficiency and greatly

the tools utilized in this analysis as part of

reduces the possibility of errors, which

their due diligence.

Disaster recovery

Not having a predetermined plan in case of an

emergency to maintain access to portfolio data
for manager and investors

1 Minimal Technology Infrastructure Risk

Minimal technology infrastructure risk: Asset managers, hedge
funds and other types of managers typically implement multiple
technology systems to support execution, portfolio reporting,
research, modeling, clearing, market data collection, cash
management, and collateral management functions in managing
their portfolios. Dozens of technology and financial services
companies provide solutions for these portfolio management and
operational needs, and it is common for firms to use a combination

31

Orchard Platform

Establish disaster-recovery plan to be implemented in case of emergency

that provides managers with continuous access to data, trading capabilities,
communication, etc.

of third-party technological tools and proprietary internal tools

to satisfy them. Investors in traditional asset classes expect as
part of their due diligence process to be shown that a manager
has implemented an appropriate technological infrastructure to
efficiently manage their business and their portfolio(s). Investors
expect the same level of appropriate operational infrastructure for
their marketplace lending allocations.
Attempting to efficiently manage a marketplace lending portfolio
using internal spreadsheets in Excelcreating, maintaining, and
updating proprietary spreadsheets, managing thousands of loans

Execution risk within marketplace lending

is the risk that investment managers may

functionalities including execution,

reporting, analysis, and data management

4 Execution Risk

Execution risk applies only when an

investment manager is actively buying
loans on origination platforms in an
attempt to generate alpha. As described
earlier, loans available through originator
platforms are perceived to be better loans
will most likely be purchased within
milliseconds by managers investing on
these platforms. Typically on originator
whole-loan marketplaces, each loan is sold
to only one investor. Even if hundreds of
investors want a specific loan, only one
will be available for purchase. Therefore,
it is imperative that active managers utilize
technological tools that will enable them
to actively purchase these loans before
others can.

is critically important in establishing

The Essential Eight Best Practices to Marketplace Lending Investing

32

VIII

ROBUST INFRASTRUCTURE REQUIREMENT

5 Counterparty Risk

6 Inadequate Portfolio Management Reporting Risk

We discussed the importance of addressing counterparty risk

The graphs on this page illustrate the benefits of this approach.

in the fifth best practice, Multi-platform Diversification.

Because of the lack of a secondary market in direct platform

Protection against counterparty risk is mainly achieved through

investing, utilizing an order management system is likely even

multi-platform diversification. However, executing across

more important in active marketplace lending investment than in

multiple origination platforms requires managers to have the

traditional investing. In actively trading markets, a manager likely

right technological tools. The number of additional originators

would only be penalized minimally, if at all, by waiting one full

a manager decides to do business with compounds the execution

second to trade a security, because the price of the security would

risk. Furthermore, a manager building multiple originator

only change slightly within that period of time. In marketplace

connections exacerbates the challenge of sharing and aggregating

lending, waiting just one second to purchase a loan could potentially

loan information as part of the managers portfolio management

result in not being able to purchase any loans that fit a managers

and operational processes. Investment managers are generally

model. Therefore, building and maintaining an interface to purchase

aware of these challenges, which is why they typically utilize order

loans with speed across multiple originators is indispensable.

management systems to efficiently trade securities with multiple

Implementing a comprehensive order management system helps

counterparties using one technological interface.

managers appropriately address the issue of counterparty risk and

other risks that could result in operational inefficiencies.

7 Inaccurate Portfolio Valuation Risk

Inadequate portfolio management reporting risk stems from a managers lack

Inaccurate portfolio valuation is a risk that was

of a reporting system that can import, export, aggregate, analyze, and store all

addressed in detail in the sixth best practice. To briefly

information about the managers positions. Most managers investing in traditional

recap, it is essential that a managers technological

asset classes have implemented a robust portfolio management reporting system,

infrastructure allow them to aggregate data across

often provided by a well-known third-party technology company that will also

multiple originators, standardize the data in a

update and maintain that system. Other managers have invested significantly

consistent format, and then provide this data file

to build, maintain, and enhance their own proprietary in-house portfolio

electronically to a third-party firm for an objective and

management reporting tools. Many managers that are considering investing in

documented valuation process.

marketplace lending have determined that within this asset class, the technological
resources needed to connect to multiple originators and to import, export,
normalize, aggregate, and store data on thousands of loans is a much larger
project than in other asset classes. Managers must therefore think carefully about
resource allocation to determine whether they want to build a proprietary system
or implement a third-party system to provide their marketplace lending portfoliomanagement reporting. Institutional investors will likely require that managers
provide them with detailed reporting throughout both their due diligence process
and their ongoing relationship with the manager.

34
33

Orchard Platform

NON-ORDER MANAGEMENT EXECUTION PROCESS

ORDER MANAGEMENT EXECUTION PROCESS

Manager

Manager

Order
Managment
System

Connectivity
Method

Connectivity
Method

Connectivity
Method

Connectivity
Method

Connectivity
Method

Originator

Originator

Originator

Originator

Originator

Originator

Originator

Originator

Originator

Originator
34

VIII

ROBUST INFRASTRUCTURE REQUIREMENT

Best Practice
8 Insufficient Portfolio
Benchmarking Risk

9 Disaster Recovery Risk

I Alpha vs Beta
Determination

Disaster recovery risk pertains to the possibility

The possibility that a manager may not be able

of an unforeseen business interruption such as a

to provide proper portfolio benchmarking and

power outage. A good disaster recovery plan will

attribution analysis is a risk that was addressed in

help mitigate this kind of risk. One core aspect of

detail in the seventh best practice. There are multiple

a disaster recovery plan should be a technological

technological requirements to solve for this risk. The

solution that will allow a manager to quickly, easily

first is for the manager to have access to detailed

and remotely access portfolio data during any

information from all originators with whom they

interruption.

Investor Checklist
Is the fund investing actively, passively, or both?
Is the fund investing directly on marketplace lending platforms, through securitized bonds, or both?
If the fund is investing actively, then what type of credit model is the fund utilizing?
Does the credit model create alpha?

II Direct Platform vs
Securitization
Investing

What level of transparency is required in my investment strategy?

What level of customization do I require within and across subasset classes?
Am I willing to extend my investment terms with a manager in exchange for potentially higher
returns and lower volatility?

do business, including grade weightings, duration

III Leverage Utilization

weightings, and seasoning of the loans over specific

How much leverage does the fund utilize, if any?

defined time periods, for purposes of comparison.

What is the cost of the funds leverage?

The second is for the manager to be able to perform

Is the fund appropriately minimizing the cost of leverage where possible?

all the necessary calculations with this data once it is

extracted from the data set.

Investor Checklist
Has the manager implemented a robust

Do I have a robust infrastructure that

provides technological and operational

and scalable?

efficiencies?
Do I have a scalable portfolio

management reporting system to

management system that provides me

properly manage their portfolio?

all the necessary functionality?

Does the manager use an order

From which originators does the manager have access to purchase loans?

V Multi-platform
Diversification

What is the investment managers due-diligence process for analyzing counterparty risk with originators?

VI Portfolio
Valuation

Does the fund have an objective and documented valuation process?

Which subasset classes does the manager purchase, and from which originators?
Is the originators supply allocation active or passive?

Manager Checklist

infrastructure that is integrated, reliable,

Does the manager have a portfolio

IV Supply, Supply, Supply

Finding, Accessing,
Acquiring

Do I have an order management system

management system that successfully

to efficiently purchase loans across

acquires desired loans needed for

multiple originators?

Does the manager invest with multiple originators to help mitigate counterparty risk?

Does the fund use a reputable and independent third-party firm for portfolio valuation?
Does the fund provide an independently aggregated and standardized data report to a third-party valuation
firm to perform a proper valuation analysis?

VII Portfolio
Benchmarking

Does the fund benchmark itself against the appropriate marketplace-lending index/es?
Is the manager capable of providing a detailed portfolio attribution report, highlighting
alpha generation?

How is the manager performing versus the established benchmark/s?

strategy implementation?
Does my technological and operational
Does the manager pass my technological
and operational infrastructure due
diligence requirements?

infrastructure pass an institutional

investors due diligence requirements?

VIII Robust Operational

Infrastructure

Has the manager implemented a robust infrastructure that is integrated, reliable, and scalable?
Does the manager have a portfolio management reporting system to properly manage their portfolio?
Does the manager use an order management system that successfully acquires desired loans needed for
strategy implementation?

Does the manager pass my technological and operational infrastructure due diligence requirements?
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Orchard Platform

Best Practice
I Alpha vs Beta
Determination

Manager Checklist
Does the originator allow me to purchase loans actively?
Do I have my own credit model?
If not, is there a quality third-party credit model I can use?

II Direct Platform vs
Securitization
Investing

III Leverage Utilization

How do I best construct my marketplace-lending portfolio to properly address my objectives?

Which investing options best satisfy the liquidity terms of my investors?
Do I plan to use leverage and/or hedge my portfolio?

ABOUT THE AUTHOR

ABOUT ORCHARD

Jeremy Todd, CFA, has over 17 years of financial

Orchard Platform is an investment and analytics platform that

services experience in sales, marketing, and

is leading the future of the credit industry. Orchard supports

business development covering asset managers,

marketplace lending by providing technical and operational

hedge funds, institutional investors, broker-dealers

efficiencies to help institutional investors, investment managers

How much supply do I need access to across the subasset classes?

and registered investment advisors. He most

and loan originators connect and transact. Founded in New

How many different originator relationships do I need to secure a sufficient and desirable
loan supply?

recently was at Barclays, where he managed the

York City in 2013, Orchard focuses on building the systems and

west coast prime brokerage business. He has

infrastructure that will allow marketplace lending to grow into a

How best do I allocate my legal resources to negotiate the loan purchase agreements?

also been a director at The Bank of New York

global financial market. Orchard enables institutional investors to

What infrastructure do I need to acquire the loans from the supply to which I have access?

Mellon, where he started the Pershing Prime

scale their investment in the space by providing investment strategy,

Services business and managed the sales team,

real-time execution and reporting, premier analytics, and access to

Does the originator pass my due-diligence analysis regarding counterparty risk?

and a managing director at Bear Stearns in global

supply. Orchard helps originators expand the credit landscape by

Am I properly diversified across multiple originators to mitigate my counterparty-risk exposure?

clearing sales. Jeremy earned a B.A. in philosophy

connecting them to a diverse set of capital providers, and enables

from the University of California, Berkeley.

them to focus on making loans and giving borrowers more choices.

jeremy@orchardplatform.com

orchardplatform.com

Should I utilize leverage in my marketplace lending strategy?

How do I obtain leverage on marketplace-lending assets?
How do I minimize my leverage financing costs?

IV Supply, Supply, Supply

Finding, Accessing,
Acquiring

V Multi-platform
Diversification

VI Portfolio
Valuation

Is my portfolio valuation process objective and documented?

Which third-party company should perform my portfolio valuations?
Which third-party company can independently provide the valuation company with an aggregated and
standardized data report to perform a proper valuation analysis?

VII Portfolio
Benchmarking

Am I benchmarking my fund against the appropriate marketplace-lending index/es?

Am I able to offer a detailed portfolio attribution report to investors, highlighting alpha generation?
How am I performing versus the established benchmark/s?

VIII Robust Operational

Infrastructure

Do I have a robust infrastructure that provides technological and operational efficiencies?
Do I have a scalable portfolio management system that provides me all the necessary functionality?
Do I have an order management system to efficiently purchase loans across multiple originators?
Does my technological and operational infrastructure pass an institutional investors due diligence
requirements ?

38

Orchard Platform

DISCLAIMERS
This document is for informational purposes only and is not intended as an offer or solicitation

A subsidiary of Orchard, Orchard Platform Advisors, LLC, is registered as an investment

to purchase or sell any loans, securities or other financial products or services, and it should not

advisor with the U.S. Securities and exchange commission and only transacts business in states

be construed as providing investment advice.

where it is properly registered, or is excluded or exempted from registration requirements.

Information presented should not be regarded as a complete analysis of the subjects discussed.
All expressions of opinion reflect the judgment of Orchard App, inc (Orchard) as of the date of
the presentation and are subject to change.

Registration as an investment advisor does not constitute an endorsement of the firm by

securities regulators nor does it indicate that the advisor has attained a particular level of skill
or ability. Any assertion to the contrary is a criminal offense.

Orchard expressly disclaims any representation or warranty as to the accuracy, completeness,

availability or timeliness of the information presented. Estimates and projections are based on
assumptions that may not come to pass.

Orchard Platform

The Essential Eight Best Practices to Marketplace Lending Investing

38

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2015 Orchard Platform Inc.