Combining stable and predictable returns with a short term, trade finance is a defensive fixed income strategy that can make for an attractive opportunity for investors, say Allianz Global Investors David Newman and Martin Opferman.
In a rapidly changing and uncertain economic landscape, investors are constantly looking for opportunities that offer profitability and stability. As market volatility improves and in an era of interest rates expected to remain high for a longer period of time, trade finance has emerged as an attractive asset class.
Trade finance, which has remained resilient in the face of recent economic uncertainty, provides financial solutions that serve as the backbone of international trade. In fact, 80-90% of world trade is based on trade finance1.
This new normal era of high interest rates raises the attractiveness of trade finance, for investors seeking refuge from uncertain markets, short maturity profiles and low risk returns.
“The long-term positive side is that the front end of the yield curve is very attractive. The yield on sterling to run the 70-day risk is around 7.5%. To get the same yield in the public bond markets, investors in BBB-rated companies are looking at a 9-year duration, which is a very different risk.” It’s size, said David Newman, CIO of Allianz Global Investors Global High Yield.
“Increasing interest costs is a risk that is suitable for dealing with trade finance because when costs increase and profitability decreases, we rotate out of those sectors or positions,” said Martin Opferman, portfolio manager, associate portfolio manager of ALWOCA. Allianz Global Investors.
Paradise of market volatility
For institutional investors, an allocation to trade finance means higher quality credit at higher fees. Investors are protected from shocks in the public equity and bond markets because short-term corporate payment demands are unaffected by market swings.
“This may suit investors looking for a high-yield, low-volatility, limited-correlation strategy with not much credit risk in their portfolio. With the shape of the yield curve, it may be doing well now,” says Newman.
While credit risk is low, it still exists and can increase during recessions or if companies hold too much debt. In the latter case, businesses are restructured while the business continues.
“As you continue to trade, you’ll often see lower default rates and, on average, recovery rates than you’d see in the public markets. That gives you a sense of volatility and relevancy,” Newman added.
Strategic positioning in the portfolio
For companies such as insurance companies, trade finance assets are attractive due to their short maturity profile and low volatility. The asset class can serve as a substitute for government bonds due to its stability and insensitivity to price changes.
“A low duration, high spread is good for insurance companies because the settlement fee is low. Investors are getting the same spread in a trade finance portfolio as a high yield bond portfolio with a capital charge of roughly 25%,” says Newman.
Commercial finance assets offer a great opportunity for institutional investors in pension schemes that want exposure to private markets but need to maintain the liquidity to support capital calls.
“Because of its short duration and similar products, it acts as a substitute for cash. Currently, due to the yield curve, investors see it as a tool that can be used as part of a liability-based investment strategy, rather than using a multi-asset credit strategy and duration overlays,” Opferman explains.
“If investors want yield but are afraid of missing out on income, the sector is really attractive because you can take exposure and hold the spread and the yield, but you can actively manage risk.”
Complexity and risk demand clarity
Although structuring a trade finance asset vehicle is complex and operationally intensive, the complexity commands a premium for investors. The key to Allianz Global Investors’ strategy is that it is structured as a global credit fund with clear diversification rules and its own proprietary vehicle.
“Our biggest credit is no more than 5%, our biggest sector is no more than 25%; we have more than 80 names in our portfolio and we don’t rely on one source of financing,” Newman reported.
While credit default, fraud and underwriting are risks that come with the asset class, Allianz Global Investors mitigates those risks by using multiple partners and conducting its own transaction analysis.
“[The securitisation vehicle] It means we can see everything that is coming. We’ll make sure the payments come in when they’re due, and if they don’t, we’ll stop extending credit immediately. We don’t trust anyone else to tell us. It means we have complete transparency,” says Newman.
1World Trade Organization figures.
Click here to download a white paper on trade finance from Allianz Global Investors.
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