AuthorMatthew Williams

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Tech fatigue

With the beginning of 2015, many tech analyst are salivating at the potential for the new Apple Watch release. Since the release of the original iPod back in 2001, each subsequent new device released by Apple has been a resounding success. Loyal Apply buyers happily lineup at Apple storefronts in droves to get a crack at their most recent releases. But are we getting to a point where consumers are becoming too overwhelmed with technology? At what point will consumers say enough devices is enough?

The original iPod succeeded for a number of reasons, but primarily because it did one thing very well; play digital music. Combined with the iTunes player and market, it quickly gained traction and grounded itself as the de facto MP3 player. And it did it with a recipe of simple, well build hardware. The iPod did little more than play music, with a monochrome screen, a navigation wheel, and not much more. Competitors featured color screens with more functionality, but lacked the minimalistic design and neglected the core function of . . . playing music. Since the iPod what we’ve seen is a convergence of technology rather than widespread diversification. The updated classic “iPod” has since been discontinued, succeeded by a line of iPod touches and iPhones. When the iPhone was released, it combined the functionality of a smart phone with iTunes and the corresponding music store to effectively make the iPod redundant for anyone who owned one. The iPhone was essentially an iPod, PDA, and phone wrapped into one supported by the walled-off ecosystem of iOS and the iTunes music/app store. Later the iPad showed even more device convergence, providing much the functionality of a PC in a smaller package. People could type out emails, browse the web, and play games much as they would have with laptop PCs, and popular add-on keyboards helped with touch screen drawbacks. However both devices continue to be popular and successful (despite recent declines in iPad sales).

Each subsequent device released by apple was a revolutionary product vastly improving on previous technology by at least an order of magnitude. So will the Apple Watch continue this trend? The Apple Watch contains vastly more functionality than its mechanical or quartz counterparts, right? It brings new functionality to a centuries-old device, however attempts in the past to improve on the humble watch have left a trail of failures. Granted, these implementations were not as advanced and many had serious design flaws, but we see a similar trend with each:

These are all hurdles tech devices must overcome, but when marketing a tertiary technology device like a smart watch these challenges are compounded. Who wants to charge yet another device at the end of the day, along with their phone, tablet, and laptop? And with the frightening pace of Apple releases, who will buy a watch with the knowledge that in half a decade (or sooner) their purchase will be essentially useless? High end watch purchases typically fall into the category of buying jewelry, which is expected to have a much longer lifespan and not precipitously lose its value. Typically these are heirloom products meant to be personalized and last a lifetime. The Apple Watch has attempted to address these issues by adding a level of customization to fit the taste of each customer. But these derivatives can only go so far.  The appeal of the device will have a limited audience of Apple customers who are willing to give up their current timepiece.

The Apple Watch is just one example of a recent re-popularized trend of connecting everything to the internet, the so called “internet of things”. This is the idea that everyday “dumb” devices will connect themselves to the internet making our lives easier, and the Apple Watch falls squarely into this category. However the fact is these devices are not new. The technology to, say, connect your fridge to the internet has been around for awhile. LG introduced the first internet fridge back in 2000, more than 14 years ago! The technology never caught on and today we’re stuck with our old dumb fridges, unable to automatically order more milk when we run dry. Yet technology experts are still heralding a new age where everything will be connected to the internet, even your kettle. Keep in mind, when consumers make a purchase of an internet-connected device, they’re also buying the service to make it work. The new-fangled “cloud” is often referenced, but in reality its just a thin veneer representing a proprietary service which might not be around in 5 years. Your smart fridge could end up an expensive dumb fridge in a few years time if LG decided they will only support the most recent models. Furthermore, buying such devices means the consumer has to first utilize their functionality and then take the time to learn the device before they become useful. Is it really easier to make a grocery list on your fridge rather than just writing it down? Do I really need to be notified on my smartphone when hot water is ready for my tea?


“Food Management”?  What happened to the old grocery list?


Additionally the industry has yet to standardize a protocol for all these devices to communicate with each other. The market is full of proprietary mechanisms of communication, devices utilize 802.XX, Bluetooth, and a host a host of others. Home automation is a mess, and with no clear market leader consumers are rightfully wary of investing thousands of dollars in their home to find out later the technology they bought went the way of the beta cassette. X10,a home automation protocol that has been around for the better part of nearly two decades, never gained widespread acceptance, even though it provides functionality many new start ups are claiming is novel today. Undoubtedly at some point a leader will emerge and technologies will standardize, but that outcome is still a very long way off.

So what about the Apple Watch? It remains to be seen how the first new device to be released under the guide of Tim Cook will fare. However its good to keep perspective on what the device actually is, and what its trying to replace. Even though it carries the Apple logo, it will still face the same challenges as its smart-watch predecessors. As we move towards more and more devices embedding themselves into everyday appliances, consumers are bound to begin to feel tech fatigue. The stress of having to keep everything plugged in and charged, updated with the latest software release, and knowing that in the not too distant future there will be a newer version making the device you have now obsolete. I doubt consumers will be willing to not only replace their phone every two years, but also every major appliance in their home. Although perhaps the prediction of a luddite, I don’t see the Apple Watch being the revolutionary device some prophesy it to be. I’ll stick with my non-digital timepiece, which does a great job of telling the time.

How to run your own bank

Both Prosper and Lending Club have been around for quite a while now and with the recent IPO debut of Lending Club on the NYSE, P2P lending has been getting ample amounts of press coverage.  However, both companies have been steadily gaining ground for a while and now have loan originations in the billions of dollars.  Along with the previous investment of Google in Lending Club, it is clear this new form of retail investing is here to stay.  Most of our readers are likely familiar with the operation of P2P lending, and what Prosper and Lending Club have done for the industry, but are probably less sure about how this type of asset class can be incorporated into their investment strategy – and more importantly the risk dynamic P2P lending adds to one’s portfolio.

Technically speaking, P2P lending falls under the fixed-income bracket of investment vehicles, putting them in the same category of generally boring, “safe” things like bonds.  These securities usually have fairly low returns, but at the same time are assumed to have less risk than equities and more predictable outcomes.  However, with P2P lending you have the possibility of seeing returns far greater than what you would see investing in bonds or CDs.  In fact, it’s possible to even beat out the average return on equities if you pick the right notes.  But does this translate instead to basically holding junk bonds or sub-prime loans?  As with any investment strategy, you need to manage your risk.  With P2P lending there are a few areas where this can be managed and built into your strategy:

Both Prosper and Lending Club both have loan terms of either 36 or 60 months and deal in only unsecured loans at the time of this article.  This means the debit has no collateral, or in other words, no lien on any asset from the borrower as would be the case, for example, in a car loan.  Because of this if a borrower defaults on a note generally it is more difficult to recover the loss.  Both Prosper and Lending Club do have collection services which will contact the borrower and attempt to recover the late loans, however the only real repercussion for a delinquent borrower is a hit on their credit rating.  Notes that have charged off are sometimes passed off to other collections agencies, in which case you might be able to recover some of the loan value (although from my experience this is rare).  Additionally, it should be noted both companies have secondary markets where you can sell notes to other issuers, this gives lenders the flexibility to liquidate their account if they need to, although depending on the number of notes, this may take some time.  There are also limits on what notes can be sold.  Lending Club restricts the sale of notes that are overdue.

So what percentage of my portfolio should consist of P2P Lending?

As with any investment strategy, this depends on a number of factors and the risk appetite of the investor.  Generally I would allocate P2P lending as a subset of my equity holdings but with the caveat that P2P assets are by no means liquid.  It could take months for someone to sell their notes on the secondary market in order to take their account to cash.  With this in mind, P2P lending falls somewhere in between the riskiness equities and fixed income.  Depending on what your current investment strategy is, diversifying your equity exposure into P2P would be my suggestion.  Think of P2P lending as investing in another company within your equities portfolio.

Which notes should I select?

This is the most apparent mechanism to manage your risk and will be covered in a later article in more detail.  There are many great resources that you can utilize to develop your own strategy, or see what others are doing.  Both Prosper and Lending Club publish their historical loan data, this is hugely valuable when designing your own criteria to select notes.  There are dozens of parameters you can use to filter notes, including the industry standard FICO credit scores along with the proprietary rating mechanisms that assign an arbitrary grade to each note.  This data, if analyzed properly, will provide huge benefits.  By filtering and slicing this data, you can develop a note filter that will work for your risk appetite and deliver the highest yielding notes for your portfolio.  Investing time to develop a good filter will pay off dividends as your notes mature.  Also, don’t hesitate to invest in higher risk notes.  Although they obviously do carry a higher risk of default, with the right strategy they will outperform higher note grades.  As an example, below is an outline of one of the filters I use to drill down to the notes I invest in:

So how much money should you invest per loan?  A good rule of thumb is to never invest more than .5% of your total account value.  In fact, I try to invest the minimal amount possible while keeping my percentage of outstanding principal as high as I can.  If there are a lot of notes on the market, I can usually get away with investing the minimum $25 for Lending Club without any problem.  However, if the markets start to get thin, I can increase that amount to keep my money invested instead of sitting idle.

Expected Returns

At this point I’ve been investing in both Prosper and Lending Club for over a year.  As an example, below are the returns I’ve experienced:
P2p Graph

Please note the returns for Propser and Lending Club individually do not take into account charge offs, total rate of return does however.  On average I’ve seen an annual rate of return around 11%-12% which is in-line with the models I used when developing my filters.  I include these figures merely as reference.  Each investor should invest in P2P lending as they see fit, and this type of investing isn’t for everyone. But for those who do, the 15-30 minutes spent each month is well worth it.


Here are some of the resources I’ve used when researching P2P lending: Excellent blog and other resources regarding P2P lending.  They also have an active forum community and put on an annual conference for P2P lending. The best site in my opinion for P2P lending analytics.  Their interface allows you to develop your own custom filters and backtest with historical data. Another analytic site which has similar functionality to NSR.

Delta Airlines reduces hedged fuel exposure

During my review of Delta’s investors day presentation, I noticed something that stuck out to me (and probably to many investors) – a $1.2B loss from their hedge book expected for 2015.  When you ask the average retail investor if low oil prices are good for airlines, you will almost certainly get a response of “yes, of course!”.  However when you dig down further you’ll find the answer isn’t as cut and dry as it first sounds and depends greatly on a number of factors, including which airline is being discussed.  In the case of Delta, as apparent in their most recent investor presentation, lower oil prices have lead to a rather large loss and a restructuring of their hedge book.  So how did Delta end up in this situation?


Oil has become an increasingly volatile commodity which has forced airlines to adopt hedging strategies in order to protect themselves from future price fluctuations.  In the case of Delta, their hedging strategy has been very active as opposed to passive, some might even argue innovative.  Their highly publicized and controversial purchase of the Trainer refinery is probably their most apparent sign of their strategy, although behind the scenes Delta has run a very active desk in house to manage their fuel hedge book.

From the investor presentation this week, however, it is clear this active strategy is starting to show signs of strain.  Along with their projected loss of $1.2B for 2015, they disclosed 65% downside participation for 2015 along with a 100% (“full”) downside participation for 2016.  This suggests a few things, firstly that Delta is expecting the price of oil to stay suppressed into 2016 and large unpredictable drops in the price of oil for the foreseeable future.  Additionally, as they are moving towards full downside participation they are undoubtedly reducing their hedge book overall scope and drastically reducing both swap and collars from their book.  Their increased reliance on call options is a sign they are moving towards a traditional “passive” hedge scenario, where they are simply guarding themselves on a steep increase in oil prices.  The cost of these options however are not insignificant, and as they become more dependent on them they will have to reduce the overall scope of their hedge book compared to their overall fuel strategy.  Delta has had issues with its oil hedging in the past, it seems they’ve assessed the losses associated with their swaps and collars were too great and exposed them to too much risk going into 2015 and onward.

But what does this mean for Delta’s venture into refining?  For Delta, their fuel hedging is broken out into two general areas, the crack spread and the cost of raw materials (oil) for refinement into Jet A.  There exists very few financial instruments to hedge against Jet A which is why airlines tend to hedge using more liquid commodities such as oil and kerosene.  The other side to the hedging strategy involves the crack spread – the cost per barrel it cost to convert crude oil to refined Jet A.  Delta’s refinery fits right into this part of its hedging strategy as they expect to see the crack spread continue to increase.  By owning and producing its own Jet A, Delta can limit its exposure to sharp increase in the crack spread.  Although the refinery has a large initial capital investment on the part of Delta ($150M, plus cost of refurbishment), in the long run this will most likely continue to be part of its long term hedging strategy.  Delta said the refinery will produce $75M  in profit for this quarter alone, which is a marked improvement from the $41M loss in the first quarter of this year.  They are specifically looking for the refinery profits to now offset the losses being incurred by its hedge book.  It is unclear however as to how the refinery will continue to perform going forward.  The increased downward pressure of oil should in theory help the refinery profits, however in time the crack spread will begin to shift to take into account the depressed cost of raw materials.  Although Delta would like to tout its relatively new refinery as an easy money maker, the refinery business is a crowded and competitive market, and a costly one to run especially for an airline whose core competency doesn’t reside in oil refining.  Its not as easy for Delta to dump an entire refinery as it is for them to rearrange their hedge book.  Plus, from a PR perspective, offloading their refinery would cause unwanted negative press and probably spook their investors.  I see Delta holding onto their refinery for the foreseeable future as they continue to explore how they can leverage it to mitigate their crack spread exposure.  Other airlines will be closely watching how Delta fares with their relatively new venture, and might outline strategies other airlines could try to replicate in the future.

Delta is a unique example compared to other airlines.  Southwest for example, which famously hedged all of their fuel buys and recorded $221M market to market loss when fuel prices rose in 2012, is proof in point that a hedging strategy from one extreme to another isn’t a good idea.  It will be interesting to see how Delta continues to adapt their fuel cost management, however it is clear they are expecting continued depressed oil prices for the foreseeable future, and have reduced their hedge book accordingly.