Blue Elephant Capital Management

Elephants and Dinosaurs

A few days back we were sitting around the Blue Elephant office discussing what all finance professionals talk about on quiet summer days – namely how little of what we learned in high school physics is still considered accurate. Granted, no one present would be considered a physics expert, but the idea is still disconcerting. How could this happen? The truth is, classic physics has been eroded by a nasty combination of time and technology, creating a new reality that is inaccessible to those who came before. Thinking about the world in the old way may not be catastrophic, but it is impossible to understand modern physics without admitting that the world has in fact changed.

Later on, I found myself thinking – Isn’t there a major parallel between the evolution of physics and the evolution of borrowing and lending? Blue Elephant can attest to the fact that lending is changing – we are helping it along. Rewind 50 years and getting a loan was done locally. “John the farmer? I know his family. Of course my bank will lend to him so he can expand his farm.” As banks grew larger, and made a larger portion of their profits either from corporate size lending or leveraged trading books, this type of lending faded away.

Sure, most people still walk into a bank, or visit a bank website, to borrow money. Those same people will tell you that away from conforming mortgages, which are ultimately backed by the US Government, most banks have little interest in extending credit to consumers. Enter peer-to-peer lending, where the concept began simply as, “Why can’t I lend money to you, person to person?” The answer is, that with a technology provider who can quantify the risk, it is possible. However, there are more people who need to borrow than are willing to lend. Peer-to-peer is now slowly turning into what we believe will be called “Marketplace lending” where pools of capital, acting through strong underwriters, will become the marketplace for borrowers and lenders. The concept has started to get some recognition, but the numbers suggest that about .02% of all consumer credit is accessed this way. I can’t help but wonder if the physics parallel is here – will our children look at us in a few years when they need to finance a purchase and wonder how everything we taught them about borrowing money was wrong?

The answer to this question is “yes” – inevitably most of what we know about the flow of money from borrower to lender has been eroded by time and technology. Blue Elephant exists in part to help this new marketplace along, making a good profit for our investors along the way. The trick will be to change with the times, as critical mass has been hit and the pace is about to accelerate.

We all struggle with the fact that technology is changing the way we need to look at investing. Deep down we know this – how many ETF’s had you looked at 10 years ago? Blue Elephant may be a startup in that it has only been around a year, but we’ve been looking across capital markets for the better part of 20 years and seen the stages of technological change. They are very similar to the stages of grief – denial, anger, bargaining, depression and acceptance. It makes sense, in that no one wants to feel like an investment dinosaur (Blue Dinosaur would be a terrible name for a fund). We are all inclined to look at stocks and bonds as the pillars of portfolio diversification. At the same time, it is evident that the opportunities in these asset classes have diminished as more capital chases fewer returns. Even more terrifying, it looks like the correlations have increased, leaving us all with less diversification that we would like. As investors come around to marketplace lending as a legitimate asset class with strong risk/return profile, we believe that it will become part of broader asset allocation across retail and institutional investors.

Instead of being a dinosaur, why not be an elephant? Elephants are majestic creatures. They move slowly, plodding along, eating 200-600 lbs. of food a day. That’s a lot. When necessary, these 12,000 lb. animals can run at speeds around 10 miles per hour, and we’ve been told the blue ones can be even faster. Anyone want to run with us?