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CROWD-FUNDING IS NOT CHILD’S PLAY

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Mark Sisson

Mark Sisson, Managing Director at 4most Europe warns would-be investors to take heed.

Since recession took hold, lending to small businesses has reduced significantly as banks look to boost balance sheets to meet stringent capital adequacy requirements.  And so enter, crowd-funding or peer-to peer-lending which threatens to fill this void.  Add to that the persistent low interest rates which have resulted in savers getting a very poor return via the traditional savings route, and the returns offered by crowd-funders starts to look very appealing indeed.

Mark Sisson

Mark Sisson

From the borrower perspective, there are certainly a string of benefits to be had; speed of decision for one – after all, banks are bound by process and may take months to make lending decisions, but a crowd-funder could make an advance in half the time.  But while limited due diligence is required to secure start-up funding, significant equity is often expected as part of the deal so one might argue it’s not a panacea.  Then you have choice of investment; one chooses which sort of business to invest in, that way owners feel their investors are genuine enthusiasts and endorsers of their business idea.  And of course you have the spread of invested funds across multiple opportunities (often hundreds) so any individual failure has an insignificant effect on return.

What could possibly go wrong?  I’ll tell you.

Lack of robust data analysis

While the quality of accepted loans and equity sourced via crowd-funding has typically been good in the past, it’s likely that as the market grows, a more diverse set of applicants will use this route to gain funding.  Simultaneously investors will become more willing to move down the risk curve in search of higher returns.  That in itself is fine; however, growing larger and more diverse requires a significant improvement in the quality of the analysis available to investors; ideally, to mitigate the information asymmetry between traditional lenders and retail investors using crowd-funding sites.

Credit risk is not child’s play and pricing correctly for the long term has taxed experts’ minds and has yielded only limited success. Crowd-funded lending is by its very nature a market; markets are good at discovering the price of commodity items which are easily transferable, be that company shares or bushels of corn. Loans to individuals and small companies are not in themselves a commodity, the loans are provided to individuals and small companies that differ widely in their ability to repay and how they might react in an economic downturn.  Large financial institutions can treat pools of loans as a commodity but only with the backing of robust and comprehensive data and analysis. Sloppy underwriting and inaccurate information can quickly catch even relatively large well-capitalised investors out.  To expect individuals to compete with volume players is unrealistic; they will more likely get their fingers burned to the detriment of the industry and possibly the economy.

When is a good idea not a good idea?

The other danger of crowd funding is that business ideas that would ordinarily fail the rigour and scrutiny of the traditional bank loan would nevertheless gain funding approval through less-rigorous channels, whether they are particularly good or innovative ideas or not, resulting in a market akin to the dotcom boom in the late nineties.  One has to question if you you can’t convince educated, savvy backers to invest in a business perhaps the idea isn’t so good after-all?

From an investor perspective, whilst funds are spread thinly and widely across multiple investments, there remains the possibility that the crowd-funding company itself will fail for the above reasons alone, resulting in total loss being incurred.

Investor check-list

To avoid the potential of total loss, would-be investors need to understand the risks via:

  1. Publishing detailed tracking information. This should include expected and measured performance of risk grades for similar assets lent to in the past as well as the performance of the debt collection function on debts that have defaulted.
  2. Providing the underlying anonymised facility level data so independent parties can verify that performance and check model assumptions
  3. Providing a flexible online tool to make it easy for prospective investors to understand the potential losses of their portfolio under different stressed economic conditions.

Closing this information gap would be a big step forward in countering potential regulatory concerns of the downsides of crowd-funding that are not fully apparent to investors.

Capitalisation

One of the key risks for potential investors is also to understand the liquidity and credit risk of their pool of loans. In basic terms, this translates to how easy would it be to get your money out before the legal maturity of the loans and how much will you be able to recover if the counterparty you are lending to defaults on their obligations?   In a standard bank account the answer is that unless the bank is made bankrupt you can take your money out at any time and the counterparty risk is nil (the bank covers any losses out of capital).  To ensure that banks can live up to those promises and always give your money back the regulators require them to hold sizeable capital buffers. Beyond this there is a FSCS scheme that ensures the first 80k of losses even if the bank does go bust. This makes banks pretty safe to ordinary depositors.

By contrast while returns may be much healthier for peer-to-peer lenders and crowd-funding sites, there is either no guarantee on liquidity and credit risks (buyer beware), or the crowd-funding site assumes this risk. If the latter then for this to mean anything it would need to be capitalised in the same way as banks are and currently they are not.

While this area has hitherto been poorly regulated, changes are afoot. The PRA and FCA are under mounting pressure from the Government and other outside bodies such as credit unions who are bringing pressure to bear on these organisations. This will undoubtedly push up their cost base resulting in lower returns to investors and more punitive terms to borrowers.

What’s next for crowd-funding?

Expect more scrutiny from the PRA in terms of ensuring crowd-funding organisations retain sufficient capital to meet potential losses and stand behind any guarantees they have made. Separately from the FCA, they will want to ensure that consumers are given appropriate, transparent and accurate information about the potential investments they are making. Comparing the investments returns to standard bank savings in marketing material has already been highlighted as inappropriate given the different nature of the risks involved.

The BIG investor question

In conclusion, the key question for investors is – do crowd-funding and peer-to-peer lending sites offer better returns because they cut out the middle man and provide a more efficient market, or are the improved returns a financial slight of hand borne out of regulatory arbitrage that hides risk in the system? At present the answer is both – until crowd-funders can demonstrate the same rigour as their regulated cousins in banks then they don’t yet deserve to be a mass-market phenomenon.

About 4most Europe (www.4-most.co.uk)

4most Europe Ltd is a specialist credit risk analytics consultancy with offices in London and Edinburgh. The company provides a range of products and services across credit risk, fraud and pricing, working with blue chip clients predominantly in the retail banking and mobile sectors. The company offers a flexible, competitive model, either working with clients to manage regulatory change or delivering and implementing business critical solutions.

Investing

Northern Trust: Outsourcing Accelerates Through Pandemic as Investment Managers Seek to Improve Margins, Enhance Business Resilience, and Future-Proof Operations

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Northern Trust: Outsourcing Accelerates Through Pandemic as Investment Managers Seek to Improve Margins, Enhance Business Resilience, and Future-Proof Operations 1

White Paper Sees Increase in Managers Outsourcing Middle and Front Office Functions to Achieve Optimal Business Structures

According to a white paper published today by Northern Trust (Nasdaq: NTRS), investment managers of all sizes and strategies have been prompted to undertake a comprehensive review of their operating models as a result of the Covid-19 pandemic which has accelerated existing trends that are compounding cost pressures. This has led increasing numbers of managers to outsource in-house dealing and other functions, such as foreign exchange and transition management, hitherto seen as core.

While cost savings remain a core driver, and indeed are one outcome of outsourcing, costs are no longer the only focus. Far from being solely a defensive reaction to increased pressure on margins, the white paper (‘From Niche to Norm’) describes outsourcing as part of the target operating model, or moving toward the ‘Optimal State’ for many investment managers, and  explains how the focus “has expanded to the variety of other potential benefits offered – enhanced capabilities, improved governance and operational resilience.”

Gary Paulin, global head of Integrated Trading Solutions at Northern Trust Capital Markets said: “The pandemic has challenged a range of operational assumptions. Working from home has, for example, questioned the need for a portfolio manager to be in close proximity with the dealing desk. Previously considered essential, the pandemic has effectively forced firms to ‘outsource‘ their trading desks to remote working setups and the effectiveness of this process has disproved the requirement for proximity, in turn, easing the path to third-party outsourcing. Many investment managers are actively considering outsourcing to a hyper-scale, expert provider as a potential, cost efficient solution – one that maintains service quality and, hopefully, improves it whilst adding resiliency.”

Northern Trust’s white paper compares outsourced trading to software-as-a-service stating: “instead of carrying the cost and complexity of running an in-house solution, firms move to an outsourced one, free up capital to invest in strategic growth and move costs from a fixed to a variable basis in line with the direction of travel for revenues.” 

Guy Gibson, global head of Institutional Brokerage at Northern Trust Capital Markets said: “The opportunity to deploy capital to build new fund structures, develop new offerings, focus on distribution and enhance in-house research has been taken up by several of our clients to the benefit of their investment approach, and to the benefit of their investors.  Additionally, in the last two months alone, many firms have recognized that outsourcing to a well-capitalized, global platform has enabled them to take advantage of cost-contained growth opportunities in new markets.”

A further development, which has echoes of the journey the technology industry has already undertaken, is the move towards ‘whole office’ solutions, which represent the next potential wave in outsourcing.

According to Paulin; “recently we have observed a growing number of managers wanting to outsource to a single, hyper-scale professional service provider who can do everything, everywhere. This aligns with Northern Trust’s strategy to deliver platform solutions for the whole office, serving our clients’ needs across the entire investment lifecycle.”

The white paper can be downloaded here.

Integrated Trading Solutions is Northern Trust’s outsourced trading capability that combines worldwide locations and trading expertise in equities and fixed income and derivatives with access to global markets, high-quality liquidity and an integrated middle and back office service as well as other services, such as FX. It helps asset owners and asset managers to meaningfully lower costs, reduce risk, manage regulatory compliance and enhance transparency and operational efficiency.

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How are investors traversing the UK’s transition out of lockdown?

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How are investors traversing the UK’s transition out of lockdown? 2

By Giles Coghlan, Chief Currency Analyst, HYCM

Just when we thought we had overcome the initial health challenges posed by COVID-19, the UK Government has once again introduced lockdown measures in certain regions to curb a rise in new cases. This is happening at a time when the government is trying to bring about the country’s post-pandemic recovery and prevent a prolonged economic downturn.

This is the reality of the “new normal” – a constant battle to both contain the spread of the virus but also avoid extended economic stagnation.

Of course, no matter how many policies are introduced to spur on investment, traders and investors are likely to act with caution for the foreseeable future. There are simply too many unknowns to content with at the moment.

To try and measure investor sentiment towards different asset classes at present, HYCM recently commissioned research to uncover which assets investors are planning to invest in over the coming 12 months. After surveying over 900 UK-based investors, our figures show just how COVID-19 has affected different investor portfolios. I have analysed the key findings below.

Cash retreat

At present, it seems that by far the most common asset class for investors is cash savings, with 78% of investors identifying as having some form of savings in a bank account. Other popular assets were stocks and shares (48%) and property (38%). While not surprising, when viewed in the context of investor’s future plans for investment, it becomes evident that security, above all else, is what investors are currently seeking.

A third of those surveyed (32%) said that they intended to put more of their wealth into their savings account, the most common strategy by far among those surveyed. This was followed by stocks and shares (21%), property (17%), and fixed interest securities (17%).

When asked about what impact COVID-19 has had on their portfolios throughout 2020, 43% stated that their portfolio had decreased in value as a consequence of the pandemic. This has evidently had an effect on investors’ mindsets, with 73% stating that they were not planning on making any major investment decisions for the rest of the year.

Looking at the road ahead

So, it seems that many investors are adopting a wait-and-see approach; hoping that the promise of a V-shaped recovery comes to fruition. The issue, however, is that this exact type of hesitancy when it comes to investing may well slow the pace of economic recovery. Financial markets need stimulus in order to help facilitate a post-pandemic economic resurgence, but if said financial stimulation only arrives once the recovery has already begun, the economy risks extended stagnation.

It seems, then, that there are two possible set outcomes on the path ahead. The first is a steady decline in COVID-19 cases, then an economic downturn as the markets correct themselves, followed by a return to relative economic stability. The second potential outcome is a second spike of COVID-19 cases which incurs a second nationwide lockdown – delaying an economic revival for the foreseeable future. At present, the former of these two scenarios is seemingly playing out with economic growth and GDP steadily increasing; but recent COVID-19 case upticks show that it’s still too soon to be certain of either scenario.

A cautious approach, therefore, will evidently remain the most common investment strategy looking ahead. But investors must remember that, even in the most uncertain times, there are always opportunities for returns on investment. Merely transforming a varied portfolio into cash savings risks a long-term decline in value.

High Risk Investment Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. For more information please refer to HYCM’s Risk Disclosure.

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Hatton Gardens 5 top tips for investing in Diamonds

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Hatton Gardens 5 top tips for investing in Diamonds 3

By Ben Stinson, Head of eCommerce at Diamonds Factory

Investing in diamonds can be extremely rewarding, but only if you know what to look for. For investors who lack experience, finding your diamond in the rough can be quite daunting.

For even the most beginner of diamond investors, the essentials are fairly obvious. For instance, you need to ask yourself will the diamond hold its value over time? What’s the overall condition of the stone and the jewellery? Is there history behind the item in question?

Although common sense plays a big part in investing, people often need insider tips and tricks to go from beginner to expert. Tony French, the in-house Diamond Consultant, at Diamonds Factory shares his professional knowledge on the 5 most important things to look for when investing in diamonds.

1: Using cut, weight and colour to determine value

Firstly, consider the shape, colour, and weight of your diamond, as this can play a pivotal role in guaranteeing growth in the value of your item. Granted, investing trends change with time, but a round cut of your diamond will almost always be the most sought after. The cut of your diamond is incredibly important, as it can influence the sparkle and therefore, the overall value. It’s a similar story for the intensity of some colours, such as Pink, Red, Blue, Green etc. Concerning weight, the heavier (bigger) stones will generally increase in value by a bigger percentage. Collectively these factors also contribute to the supply and demand aspect, which will determine their high price, and will ensure your item is re-sellable.

2: Provenance

Looking for significant value? Well, aim to own jewellery or diamonds that come from an important public figure. If you’re lucky enough to own a piece that has significant history, or was owned by a celebrity or person of interest, it’s an absolute must to have concrete evidence of this. Immediately, this proof will increase an item’s overall value, and there’s a good chance the stardom of your item might drum up interest amongst diehard fans, increasing the value even further…

Equally, it’s possible to proactively bring provenance to unique diamonds of yours. For instance, you can offer to loan bespoke, or unusual pieces for film, theatre, or TV performances – then it can be advertised as worn by xyz.

3: Find the source

Ben Stinson

Ben Stinson

Establishing your diamond’s source is one of the most important things you can do when investing in diamonds. If you’re starting out, try to purchase diamonds that have NOT been owned by too many people, as the overall value of the diamond will reflect multiple ownership. Alternatively, I’d always recommend buying from suppliers like ourselves or other suppliers and retailers, who buy directly from the people who have had them certified.

Primarily, this will allow you to have a greater degree of transparency, which is crucial when buying such a valuable item. Next, you should immediately see an increase in value of your diamonds, as identifying a source will allow traceability and therefore, market context.

4: Certification

Linked closely with my previous point, is the requirement to ensure that your diamonds are certified by a credible lab, and you have the evidence to prove so (a written document with specific grading details about your diamonds) – this will remove any doubts of impropriety.

It’s essential to remember that not all labs are the same, and many labs are better than others. Both the AGS (American Gem Society) and GIA (Gemological Institute of America) have great reputations and are world renowned. I’d recommend doing your own research into the labs, and when you’ve found the pieces that you’d like to invest in, then make an informed decision based upon your findings. Ultimately, proving certification will make your stones easier to insure, and deep down, you can have peace of mind knowing you have got what you have paid for.

Don’t forget to keep this paperwork in a safe location as well – you’d be surprised how many people we’ve met who have lost, or forget where they’ve placed it.

5:  Patience is a virtue…

If the market is strong, it might be tempting to look for an immediate sale once you’ve purchased a high value item. However, I suggest holding onto your diamonds for some time before even thinking about selling. More often than not, an item is more likely to increase in value over a few years than a few days – try and wait a little longer!

Equally, I would encourage having your diamonds, or jewellery professionally valued regularly. If you don’t have the knowledge to make a rough judgement on how much your pieces are worth, a consultant or expert can provide both a valuation, and contextualise that amount in the wider market. From there, you should be empowered with the knowledge to decide whether to keep or sell.

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