Studies of Life

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Bondora Diversification: About 500 Loans Are Enough!

28 August 2014 by Jim

Diversification is important for all your investments. For P2P lending in particular, we know that the percentage of borrowers who will default on their loan is higher than usual because these are loans made to people who would generally not easily get a loan from a traditional bank.

Bondora (formerly IsePankur) has solved this problem by allowing you to invest in tiny parts in different loans. If you have € 100 to invest, you can allocate € 5 per loan, so you’ll have a total of 20 loans and a diversified portfolio. In this situation, it does not matter much to you whether or not a single borrower defaults or does not pay back his loan as quickly as he should.

But how much diversification on Bondora is enough?

It’s logical that the smaller your portfolio is, the bigger the discrepancies between your return and the average return on Bondora will be. The more loans you buy into, the more your average metrics will start to resemble those of the whole platform itself. Having a big, diversified portfolio on Bondora is like buying an Index ETF of stocks, so you own the entire market (or close to it, anyway) and don’t get huge surprise if one of the underlying securities gets into trouble.

In the last weekly newsletter, Bondora explains that diversification smoothes returns, which is obvious as we’ve just seen. Here’s a graph with data from Bondora on how the return varies among the 10th percentile and the 90th percentile for different categories of diversification.

Bondora Diversification Returns

As you can see, among the investors with less than 100 loans, the average return for the worst 10% is below 7%, for the best 10% it’s almost 30%. That’s a huge variation. But when you look at the more diversified groups, the difference between the 10% worst and 10% best investors starts to shrink rapidly. For investors with more than 500 loans, the average return ranges from 17% to 26%. As you can see, overall the median return increases with increasing diversification. But the benefits of diversification are not limitless. According to Bondora’s newsletter:

We did not see any significant added benefit of diversifying between more than 500-600 investments as the average returns are very similar to those who have diversified between 1000+ or 1500+ investments. If your portfolio already includes more than 500 investments and you have additional funds to invest, you can increase the amount invested per borrower or widen your portfolio managers to increase your returns by reducing loss due to cash drag.’

So 500 – 600 different loans is all you need to reap the benefits of diversification.

If you already have that kind of diversification, you can widen your portfolio managers, i.e. invest in a larger range of different loans by relaxing your selection a bit, and increase the amount to invest per borrower in order to be fully invested as much as possible. If you have € 5000 standing idly in your account without being invested, you are not getting any return on them. A 21% return on your Bondora portfolio (which is my current ROI) effectively gives you 2% return per month, so you should not waste time with cash sitting idly by, and make sure you’re invested fully. Here’s another way to increase the return of your Bondora portfolio.

How diversified are you? I currently have 502 current loans (not counting any overdue or defaulted ones) after over a year of investing and about € 60000 in capital injection.

 

 

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