Providing stable and predictable returns coupled with short duration, trade finance is a defensive fixed income strategy that can produce an attractive opportunity for investors, say David Newman and Martin Opfermann.
In a rapidly changing and uncertain economic landscape, investors are constantly seeking opportunities that offer both profitability and stability. As market dynamics evolve and in an era of interest rates that are expected to be higher for longer, trade finance has emerged as an attractive asset class.
Trade finance, which has maintained its resilience through recent economic uncertainty, provides a range of financing solutions which serve as the backbone of global trade. Indeed about 80 to 90% of world trade relies on trade finance.[1]
This new normal era of high interest rates heightens the attractiveness of trade finance as an investible asset class for investors who seek a haven from uncertain markets, a short-term maturity profile and low risk returns.
"The positive side of higher for longer means the front end of the rates curve is very attractive. Yields in sterling terms are around 7.5% for running 70-day risk. To get the same yield in public bonds markets, in the BBB-rated companies, investors are likely looking at a 9-year duration, which is a very different amount of risk," says David Newman, CIO Global High Yield, Allianz Global Investors.
"Rising interest costs are exactly the risk that trade finance is suitable for coping with because as costs rise and profitability goes down, we rotate out of those sectors or positions," says Martin Opfermann, Lead Portfolio Manager, Co-Portfolio Manager of ALWOCA, Allianz Global Investors.
A haven from market volatility
For institutional investors, allocating to trade finance means high quality credit at an extra premium. Investors are insulated from the shocks seen in public equity and bond markets largely because the short-dated corporate payment claims are unaffected by market gyrations.
"This could really suit investors who want a higher yielding, low volatility, and limited correlation strategy with not too much credit risk in the portfolio. With the shape of the yield curve, it could work well right now," says Newman.
While credit risk is low, it is still present and can heighten during a recession or if companies carry too much debt. In the latter case, businesses will restructure while continuing to trade.
"By continuing to trade, you often see lower default rates and higher recovery rates for the average rating than you would see in public markets. That gives you a dampening of volatility and of correlation," says Newman.
A strategic position in a portfolio
For firms such as insurance companies, trade finance assets are attractive due to their short-term maturity profile and low volatility. The asset class can be used as a replacement for government bonds due to its stability and insensitivity to rate changes.
"Low duration, high spread is good for insurance companies because the solvency charge is low. Investors are getting a similar spread on a trade finance portfolio as a high yield bond portfolio with approximately 25% of the capital charge," says Newman.
Trade finance assets offer a significant opportunity for institutional investors like pension schemes that want exposure to private markets but must retain liquidity to fund capital calls.
"It works as a cash substitute due to the short duration and similar yields. Currently, because of the yield curve, investors are looking at it as an instrument that can be used as part of a liability-driven investment strategy rather than using a multi-asset credit strategy and duration overlay," says Opfermann.
"If investors want yield but are also afraid of missing out on the income, the sector really has appeal because you can take the exposure and can capture the spread and the yield, but you can also manage risk actively," says Opfermann.
Complexity and risk require transparency
While structuring a trade finance asset vehicle is complex and operationally intensive, the complexity gives investors a pickup in premium. The key to the AllianzGI strategy is that it is structured like a global credit fund with clear diversification rules and its own proprietary securitisation vehicle.
"We have no more than 5% in our biggest credit, no more than 25% in our biggest sector, we have over 80 names in our portfolio and no reliance on one source of finance," says Newman.
While credit default, fraud, and insurance are all risks that come with the asset class, AllianzGI reduces those risks through utilising a number of sourcing partners and conducting its own transaction analysis.
"[The securitisation vehicle] means we can see everything coming through. We make sure the payments come in when they are meant to be and if they do not, we stop extending credit straightaway. We do not rely on anybody else to tell us. It means we have full transparency" says Newman.
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[1] https://www.wto.org/english/thewto_e/coher_e/tr_finance_e.htm#:~:text=Some%2080%20to%2090%20per,of%20a%20short%2Dterm%20nature.
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