Income Sharing Agreements: The Future of Alternative Investments
Going long and short people, professions, places? Maybe a not so distant future.
Before we get into the really interesting parts of income sharing agreements and draw more broad implications, we have to understand the basics.
DISCLAIMER: This article references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.
What are Income Sharing Agreements?
An Income Sharing Agreement, often abbreviated as an “ISA”, is a financial agreement typically between an organization and individual to provide financing in exchange for a portion of future income.
The most common type of ISA currently being used is in the context of higher education, as a replacement for a typical student loan. As they currently stand, these ISAs act much like a loan with an income-based repayment plan, in the sense that after the owed amount is paid back with the owed interest, the agreement ends.
Let’s look at an example of what an ISA might look like in practice:
Dan is a bright young man who just graduated from highschool, and is now entering his first year of university at Stanford, going into computer science. Unfortunately, Dan is coming in as an international student from the UK, so he has very limited access to financial aid, and his family can’t afford to pay his tuition. Dan’s first thought is to apply for a student loan, but given the repayment plan tends to be quite strict, he might be forced into getting a job immediately, instead of doing research like he wanted.
After doing some browsing, Dan realized an ISA is the perfect way to finance his education. Going to Stanford, both he, and the organization providing him with the agreement, understand he will easily be able to pay back the money in the long run. Now, Dan is able to go to Stanford without worrying about getting a job immediately after, and the ISA provider is happy to accumulate interest on what is a very safe, long-term investment.
Dan is provided with a number of options for the terms of his ISA. He can pay a larger percentage of his income, and get a better interest rate, or conversely, a lower percentage of his income with a higher interest rate.
Two sides to each coin…
The Advantages
As we see from the example with Dan, ISAs allow for much greater flexibility for the borrower. They don’t have to worry about getting a job immediately, nor any deadlines by which they need to make payments. ISAs are also far less risky for a student, in the case they lose their job, or don’t earn as much as they would have expected after graduating.
Research also indicates that students with greater financial burdens out of college are more likely to begin with a lower starting salary, since finding a job quickly is often prioritized over finding a well paying job. (How Credit Constraints Impact Job Finding Rates, Sorting & Aggregate Output)
For the lender, or provider of the ISA, they don’t have to worry about an ISA defaulting if someone loses their job or goes bankrupt, as they are guaranteed a percentage of the person’s income until they are paid back with interest. The only risk is if the borrower passes away — a risk that exists in providing traditional loans as well.
The Catch
Alas, not everything is sunshine and rainbows with ISAs, at least for now. These agreements are still very new, and have less government regulation, in stark contrast to student loans, which have very stringent rules and enforcement. Accordingly, Big Tech and private equity are jumping at the bit to capitalize on the opportunity.
Among others, Google and Blackstone are flooding into the market, itching to make ISAs the default method of financing for higher education. Just as student loans are ballooning in the United States, new figures are showing that ISAs may be even worse than what they were designed to replace:
Assuming that a student began to make $50,000 a year — the average starting salary for a bachelor’s degree recipient — and then saw a 2% raise each year, she would pay around $65,700 back in the end. “That’s the equivalent of an interest rate of 18.4%,” Kantrowitz said. (The rate on federal student loans is closer to 5%.)
-Annie Nova, CNBC
The Securitization of ISAs
So far we’ve looked at how ISAs work in today’s world, but let’s look at them in the context of public securities.
Currently, most ISAs are provided by organizations, but what if they could be traded just like a stock or bond on a public exchange? Well, that’s been the inspiration for platforms like edly.co, now processing millions of dollars and working with students from 100s of universities across the United States.
What It Could Mean for Investors
Obviously, ISAs present a highly attractive offer for investors, with one Edly account offering a target 14% IRR — almost double that of the stock market. But perhaps what’s even more fascinating is what pre-packaged ISA ETFs could look like in the future.
Imagine a “Doctor ISA ETF”, composed of a diversified set of ISAs for students entering, currently in, or graduates of medical schools across the country. The ETF price would be tied to average salaries for doctors in Canada, essentially letting you bet for or against wage increases for an entire profession. This is because if their wages increase, the portion of their income going towards the ISA will be larger in absolute terms, reducing the time it takes to pay back. By definition, the time value of money principle tells us that the value of the security will then increase. Alternatively, there could be region-based ETFs, allowing investors to have long positions on specific cities where they believe wages will increase, and short positions where they expect wages to decline.
Let’s look at an example of what an investment decision for ISA ETFs might look like some in the future:
Dan, now having graduated from Stanford and paid back his ISA in full, has saved up a lot of money and wants to invest it. After doing some research, Dan learns that the number of students wishing to become teachers has dropped considerably over the past 4 years. After checking teacher ISA ETFs, he finds that they have remained stable for many years. Dan realizes that the market is failing to anticipate a shortage of teachers, which would intuitively boost wages in the coming decade, and so he buys the ETF. His intuition served him well, as the very next year, there was massive news story about incoming teacher shortages across the nation, which immediately led investors flocking to the ETF, and sending the share price soaring.
What It Could Mean for Society
Before any of us start saving up and telling everyone we know to buy ISAs, let’s take a step back and think about what the larger implications are. At the end of the day, an ISA seen as a financial security will allow us to take stock in a person’s future. Instead of a DCF forecasting a company’s future earnings, we would be forecasting a human being’s earnings and putting a price tag on them based on where they live, where they go to school, and what career they pursue. Is that a reality we want to live in?
As fun as it might be to picture the idea of going long or short a person, profession, or region, we have to take into account our morals as a society, and think hard about what we want tomorrow’s world to look like.
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Sources
You Can Securitize People Now — Bloomberg
Income sharing agreements could cost students more than loans (cnbc.com)
