Last November, we published our updated diversification analysis on the range of returns realized in the portfolios of over 11,000 GROUNDFLOOR investors up until that time. We’ve updated and enhanced that analysis for this, our seventh edition. The data now includes 18,050 portfolios, with 1,545 LROs repaid, representing over $209M in principal invested (as of July 26th, 2021).
As many readers know, diversification is a risk management technique that mixes a wide variety of investments within a portfolio. When properly diversified, a portfolio should yield higher returns and lower risk more reliably than will a single investment or a small number of concentrated investments held in a similar portfolio. Diversification is a strategy intended to negate risk events that are unique to any particular investment in a portfolio. With diversification, the negative performance of some investments is expected to be countered by the positive performance of others.
GROUNDFLOOR’s minimum investment size of $10 was designed to be an intentionally low barrier to diversification. GROUNDFLOOR investors not only choose which loans to invest in, but also how much principal to allocate to each loan. A total investment of $1,000, for example, can be allocated to one single loan or as many as 100 different loans, giving investors the ability to diversify their portfolios as much or as little as they like in accordance with their personal financial situation and risk tolerance.
The Effects of Diversification on Portfolio Returns
Our updated analysis shows how investors’ portfolios have performed overall since GROUNDFLOOR first started offering investments over eight years ago. The chart below shows the relationship between the number of LROs held and the average returns realized for investor portfolios on our platform. Each dot represents an anonymous individual investor portfolio containing a number of LROs (plotted along the x-axis) that has realized a given annualized rate of return (plotted along the y-axis).
The average annualized returns for investors' portfolios is 9.98%.
Our analysis shows that a hypothetical model portfolio composed of an equal investment made in all 1,545 LROs repaid to date would have earned an annualized net return of 9.98%. Analyzing our current outstanding loan portfolio would similarly yield an annualized net return of 10.04%, assuming all outstanding loans perform and deliver the contract interest rate.
For this analysis, we maintained the same method of calculating portfolio returns as we employed previously. Like in our past analyses, we calculated portfolio returns by dividing the amount of interest earned for each investment by the amount of principal invested, and then annualizing that figure (dividing it by the number of days the loan corresponding to the LRO was active, then multiplying by 365). Each annualized return is then weighted by the amount invested as a proportion of all principal invested in the portfolio. Reinvestments are accounted for as new, separate investments. Balances held as available cash in GROUNDFLOOR Accounts are not included in the analysis, since they are not invested and can be withdrawn upon demand.
Once again, as the theory of diversification predicts, portfolios invested in the largest number of LROs realized the most reliable returns. This is true even though GROUNDFLOOR investors, unlike investors in REITs or other funds, decide not only which LROs to include in their portfolios, but how much capital to allocate to each LRO, relative to the others. The diversification enabled by the GROUNDFLOOR platform is that strong -- and GROUNDFLOOR investors are able to achieve a greater level of it than is provided by competing online REIT products.
The Effects of Diversification on Loss Ratios
The portfolio returns reported above are reported net of losses. This means losses are taken into account in calculating the return presented. Many investors want to understand not only the net rate of return, but also the level of losses they can expect when investing to get to that net return. This measure of losses is encapsulated in a useful metric called the loss ratio.
The loss ratio is the amount of principal lost expressed as a ratio to the principal invested. A loss ratio of -5.0%, for example, would mean that $50 was lost out of every $1,000 invested. Similar to the rate of return chart, the chart below illustrates loss ratios realized by individual portfolios compared by the number of LROs held in each portfolio.
GROUNDFLOOR portfolios have experienced an average loss ratio of -0.69%.
A model portfolio composed of equal investments in all 1,545 LROs repaid to date would have experienced a loss ratio of -0.69%. Just as it has been every year since our inception in 2013, our loss ratio continues to be less than 1%, even as more loans are added to our repaid portfolio.
Portfolio Returns and Loss Ratios for Loans Repaying Past Maturity
The powerful effects that diversification can have on portfolio returns remain valid even when looking at loans that were repaid past maturity (i.e., in workout or default). As of July 26, 2021, 566 LROs to date were repaid past maturity. The charts below showcase the returns and the loss ratios realized for these 566 LROs:
The average annualized return for LROs repaying past maturity is 9.52%.
The loss ratio experienced for LROs repaying past maturity is -1.75%.
A model portfolio consisting only of LROs that repaid past maturity would have generated an annualized net return of 9.52%, while experiencing a loss ratio of -1.75%. Even if by some stroke of bad luck, every loan held by a hypothetical investor repaid past the maturity date, that investor would not have experienced losses as long as they had invested in a large enough sample of the full population of those loans.
The above data also demonstrates that just because a loan doesn’t repay by the maturity date doesn’t mean that the borrower is delinquent or that the loan won’t yield a positive return. As we have advised before, loans that go into default or workout do not necessarily (or even usually) result in losses. In fact, in many cases, the borrower has made significant progress on the project, or our Asset Management team has worked on a positive resolution with the borrower to ensure full repayment. As a result, loans that we have labeled as “default” or “workout” (i.e., those past maturity), have historically still returned over 9% yield on average.
The steady returns our investment products provide -- and the relative liquidity of these returns over the short term -- continues to be a useful alternative to public investment products, especially in turbulent market conditions such as those resulting from the COVID-19 pandemic. As we wrote in Our Perspective on Market Volatility in February, we continue to believe that investors holding private market loans backed by residential real estate at low leverage have a competitive advantage in weathering the COVID-19 storm (or any other future economic downturn) and potential for continued repricing of public and private market assets.
Over eight years ago, GROUNDFLOOR was founded to enable everyday Americans to invest in high-yield securities previously reserved for the top 5% of wealth holders and income earners. As GROUNDFLOOR continues to expand its loan origination capabilities, the extent to which our investors can diversify their portfolios has reached levels that are unprecedented in the real estate investment space. In line with our mission, we will continue to empower our investors to develop and execute their own investment strategies. Whether and how you take full advantage of this degree of freedom is up to you.
We share this kind of information to help support our investors’ success. If you have any questions or comments about this report, do not hesitate to reach out to us. You can comment below or send an email to email@example.com. We always appreciate hearing from you.