Alt Investments
INTERVIEW: An Unusual Low-Risk Asset Class - Financing MBA Students

What started as two students of INSEAD, the French business school, having trouble securing loans for their Master of Business Administration degrees, is now a $36 million community of investors and borrowers under Prodigy Finance.
What started as two students of INSEAD, the French business school, having trouble securing loans for their Master of Business Administration degrees, is now a $36 million community of investors and borrowers under Prodigy Finance, exposing demand for this relatively untapped asset class.
Chief operating officer Ryan Steele recently told this publication about his experiences, explaining how they motivated him and Cameron Stevens, chief executive, to launch Prodigy in 2007. The firm invests in the world's top business schools such as INSEAD, London Business School and Oxford Saïd Business School.
The development of this business is another sign of how, at a time when conventional bank finance has come under pressure, workaround methods are being developed to fill the gaps.
Steele sets the scene in 2005. This is a time when consumer credit markets were booming and applying for student loans was a huge market globally, he said. But even Steele, who at the time worked for one of South Africa's biggest banks as head of risk in one of the retail divisions, struggled to secure funding to study abroad.
"When we got to INSEAD we looked to see how broad the problem was and found that 60 per cent of our class had faced significant difficulties. We surveyed a few other schools across Europe and it was the same problem everywhere," he said.
Banks - even in a financial climate with plenty of liquidity - were struggling to understand how to assess risk globally and integrate clients who were from multiple countries, he says. "And of course, many of these students go back to their home countries after, so it's very hard to integrate and retain value."
Steele and Stevens turned to the alumni community to raise money for students, with the aim of creating something innovative that would give investors a good return, provide schools with a sustainable loan program and offer students competitive interest rates.
Since its launch, Prodigy has grown to a portfolio of around $36 million - with about 830 students - and Steele projects it will hit $60 million in 2013. Investors are typically high net worth individuals within the business school community and, increasingly, family offices.
"In the UK, our program funds a lot of domestic UK students as well, which is interesting because it says something about our model being able to do something even better than what local banks are doing here in terms of the process, pricing and the product as a whole," he said.
Strategy
Above all, students who apply for the loans via Prodigy must have a place secured at one of the top business schools in the world - a process that serves as a filter and leaves a "super-premium" base. The firm also developed a proprietary "affordability model" to assess post-study affordability of repayments. Similarly, risk and background checking is crucial in ensuring that risk management is "the best that it can be," Steele said.
"We are global in our approach. All of that, which you would assume a bank would do, they're not actually able to because while they can make regional decisions, they cannot look cross-border. We do a credit risk screen on every applicant," he added.
He also says the fact the loans are made within a community reduces risk: "Because you've got members of your community funding your loan, what happens is people repay exceptionally well…The community nature means the population self-polices."
Meanwhile, from a borrower perspective, Steele said demand is not a problem. "There is no solution at the moment in the market for international business school students. From an investor point of view Prodigy has developed a product with broad investor appeal amongst alumni communities, family offices and other investors looking for yield."
How it works
The interest rates offered to students are typically between 7 and 7.5 per cent, while investors get a roughly 5 per cent return. Investors buy notes listed on the Irish Stock Exchange, with each series ring-fenced by school and class. This means an investor can choose to invest into a particular school and graduating class, or into multiple series across a number of schools (a series will fund, for example, the class of Oxford 2013).
The students get 18 months of grace during which interest accrues but no payments are required - 12 months while they study plus another six months after to find a job - and then repay over a seven-year term.
While Prodigy boasts a zero default rate to date, in the event that any student does default on their repayment, Steele assures there is a plan of action. "We have a robust global legal framework that we use to enforce the obligations," he said.
Incentives
Besides investment return, Steele explained that another incentive to invest with Prodigy is that some 60 per cent of the portfolio come from emerging markets and, ultimately, between 70 and 75 per cent go back to their countries of origin.
"What's interesting is that people from developing markets have by far the biggest salary increases when they go and study at the top business schools, and they're in such high demand when they go back to their countries they get paid very well," he said, highlighting that 80 per cent have no access to traditional funding sources, which "describes the extent of the problem."
Moreover, and perhaps most crucially, the students are highly employable and globally mobile. Their employability and salaries are therefore less correlated to individual market changes. "It's an interesting asset class because it's massively diversified, and yet at the same time it's tenacious," said Steele.
One factor to watch, nonetheless, is the recent changes to UK visa requirements for students. Indeed, one effect of this is that people will need "very strong" applications – leading to a strong selection of individuals. However, from a school perspective it has meant that admissions and volume of applications have reduced.
A "very transferable" model
Steele said there are certain elements of the model that are very transferable and can be switched to other professional degrees such as short-term advanced studies in law or Masters in finance. However, this model changes at the undergraduate level because there are many layers of study, with failure rates in between. "But the community funding model is applicable all the way through," Steele said.
The business has expanded its footprint. Prodigy began by working with INSEAD in France and Singapore and then branched out to Europe. This year it will launch to US investors - a "big and important market," Steele said, noting that of the top 50 ranked business schools in the world, about 30 are in the US.
"Even with the schools we currently partner with, there are US-based alumni and family offices linked to the schools that would be able to invest. So when we expand to US schools, I think there is a far stronger appeal to US-based family offices," he said.
In fact, the firm opened its doors in Boston a few months ago, and has hired Jeremy Rabson as head of US operations. Initially, it will fund international students, because, according to Steele, there is an abundance of products available to domestic students already. The structure, support and operational capability is essentially copy-pasted to the US.
Competition
Steele says his firm is very aware of what's happening from a competitor perspective and recognizes that there has been "very little activity" in the international loan market for the last four years.
"If you look at our core focus which is international market representing and top business school graduates, there aren’t any players there at the moment," Steele said. "There are small things happening here and there but there is no global player." Recently a US company called SOFI has launched, but with a focus only the US domestic market.
Steele highlighted that total loans each year funding students from the world's top-ranked business schools comes to $1.2 billion. "But we're looking at just taking the best of the best from that, focusing on the top 50 schools," he said.
Historically, the majority of funding has come from alumni, along with members of the business school communities and family offices. "So those are key targets for us going forward," Steele said. "But we also believe there will be interest from investors looking for long-term yield."