Enhancing Fixed-Income Portfolios With Trade Finance

A Growing and Dedicated Sector Within Fixed-Income

Uncorrelated Returns · Income Generating · Asset-Backed · Short Duration · Credit Insurance

EXECUTIVE SUMMARY

Investors Searching for Yield

Given that public markets exhibit elevated valuations and are priced for perfection, investors are searching for yielding assets that can provide a suitable investment to replace traditional fixed-income. In public market fixed-income, investors face the unappealing combination of highly levered corporate balance sheets, economic uncertainty, and compressed bond yields.

Seeking Quality Fixed Income Alternative

In the current market environment, investors need to take significant duration and credit risk to generate meaningful income. This has led investors to increasingly evaluate trade finance: a highly attractive fixed income sector relative to traditional bonds and other private credit strategies given the short-tenor and duration of the financings, collateralization of transactions, and the use of credit insurance.

The Right Segment of Trade Finance

Trade finance when combined with credit insurance as a hedging tool captures a highly attractive arbitrage opportunity within fixed-income. By funding companies in the middle and lower middle-market that generate an attractive yield and where the ultimate credit risk is transferred to an insurance company that is rated A or higher, investors are earning a significant excess return relative to what they can earn for a corporate bond with the equivalent rating.

Banks have historically not syndicated these assets as they provide a low-risk return for their balance sheet. Given financial regulation, many banks have significantly curtailed or exited the area due to capital charge requirements. As a result, this is a relatively new and expanding asset class for non-bank financial institutions and investors.

WHAT IS TRADE FINANCE? A DEDICATED FIXED INCOME SECTOR

Trade finance provides working capital financing for commodities, manufacturing, processing, distribution, industrial, business services, media, and/or other commerce-related activities in domestic and international markets.

The scope of trade finance includes factoring, supply chain finance, purchase order finance, and asset/receivable-based lending (collateralizing loans with assets/receivables), and pre-export finance. All trade finance transactions occur at the invoice and purchase order level so there is the financing of trade in the truest sense of the term.

TRADITIONAL FIXED INCOME FACES INCREASED CHALLENGES AND HEADWINDS

The current market environment is characterized by:

• Elevated valuation across all asset classes with increased volatility – posing an adverse risk to long-duration assets
• Rising leverage and reduction in credit quality: decline in AAA-rated corporations from 54 in 2006 to only 2 in 2019
• Compression of yield across all sectors of fixed income
• Central banks providing continued support through asset purchase programs resulting in a high degree of market distortion and mischaracterization of the true risk