Blue Elephant Capital Management

The “Fin” in Fintech.

Technology makes travelling so much easier. I am writing this thought piece 30,000 feet in the air, on a plane that has live television and wifi access. Oh, and before I left home, I downloaded a 5 gigabyte movie on my iPad in about 20 minutes. For someone who can remember their first 300 baud modem (and can hear my mother yelling at me for tying up the phone line, sorry Mom!) and 20 megabyte hard drive – I find it pretty amazing.

Still, I have to admit that there are plenty of aspects to travel that haven’t changed very much. I still had to drive to the airport (I guess I could have uber’ed), go through security and fly the same amount of time to get to my destination. So in reality, technology has eased the pain of travel, but the fundamental aspects of it remain the same.

There are obvious parallels between my situation and the fintech space. Tech is the sexy part and the part of marketplace lending that gets all the headlines. Finance has become such a bad word in the post crisis world that it is easy to forget that the finance part of lending deserves at least as much focus. In many ways, the financial basics haven’t changed much. A borrower must still be approved, the lender and borrower must agree on a rate — and then payments must be made, or default ensues. It had been extra easy to forget this part in a world of falling interest rates and historically low defaults — but the finance part is still the most important, and the part that pays the bills.

So what does it mean to focus on the finance? For us at Blue Elephant, the first step is to focus on the macroeconomic environment and its impact on the business cycle. We have spent our careers understanding how to identify turns in the business cycle. In fact, we think there are signs out there that we’re closer to the end of this good run than the beginning. But what can we do about it? Marketplace loans are illiquid, so we can’t sell them. We can be up in quality though — taking advantage of high yields and short durations to wait out the turn.

The other thing we can do is invest across multiple platforms. We do not want to be forced to reinvest money into loans at the wrong time. We must have access to secured and unsecured loans, US dollar denominated and non-US dollar loans across different underwriters with different styles. We also reserve the right to own cash, or liquid bonds, if these markets take time to adjust to business cycle changes.

As we look at the financial markets broadly, we are concerned that the large, liquid markets have become correlated. That is, one of the more noteworthy runs of equity market history from 2009 to 2014 has been matched by rallies in fixed income markets too. If higher equity prices are correlated to lower bond yields, isn’t it likely that if we finally get the big selloff in fixed-income that everyone has been calling for, that equity prices will fall as well? In that type of environment, investors are likely to exacerbate price drops by selling their liquid assets. One of the advantages of the asset we own is that it has a high yield and low duration, with few forced sellers to depress valuations.

In will write more on correlations over the next few weeks, but for now the important realization is that 2015 could be a year where the fin steals the show from the tech.