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How Trade Finance Fits Into The Current Yield

Jun 30, 2022Industry Insights

According to a recent article in the Financial Times, cross-border trade is currently being fueled by trade finance. However, due to changes in regulations, many banks are now forced to de-risk. As a result, nonbank entities have stepped in to fill the gap.

This surge in private debt investing has been made possible by the new era of private debt providers who offer higher returns and diversification than traditional bond investments. Many investors are attracted to this form of private debt because of its short duration and risk-adjusted returns.

However, some investors are hesitant to invest in private debt due to the lack of liquidity and duration risk.

Overall, trade finance debt is an attractive option for investment portfolios due to its current moment of low interest rates. Thanks to the efforts of private debt providers, cross-border trade can continue to thrive.

The New Kids On The Block Greasing The Wheels Of Global Trade

Today, nonbank entities are answering the call for more flexible sources of capital to fund global trade. These entities can take a more tailored approach to finance trade assets, allowing them to act quickly and provide more flexible terms. This is attractive to borrowers who are willing to pay a premium for this type of financing. As a result, private debt is swelling as one of the fastest-growing asset classes.

The global financial crisis forced banks to adopt a more conservative approach to lending, which made it harder for small and medium-sized enterprises to get funding for trade. However, trade finance is a lucrative investment opportunity with attractive returns and low default rates. Nonbank entities have stepped in to fill the funding gap, providing more flexible financing terms that borrowers are willing to pay a premium for. Private debt has grown rapidly as a result, becoming one of the fastest-growing asset classes.

If you’re involved in global trade, it’s important to be aware of the different financing options available to you. Trade finance can be a great way to get the funding you need, but it’s important to understand the different types of financing available and how they can best be used to meet your needs.

Growing Hunt For Yield Lands At The Door Of Private Debt

As investors search for yield in a low interest rate environment, some have turned to private debt. Private debt can offer higher regular income than many traditional bond investments, as well as diversification and limited exposure to investor speculation. However, private debt also typically comes with a lack of liquidity, which can be a hindrance for some investors.

One type of private debt that may be worth considering is trade finance. Trade finance typically has shorter terms than other types of private debt, meaning there is less of a liquidity issue. Additionally, trade finance can offer opportunities for portfolio management and risk reduction. If you’re considering adding private debt to your investment portfolio, trade finance may be worth exploring.

The Rise Of Trade Finance As An Asset Class

As the trade finance loan reflects the short-term nature of the underlying asset, with an average maturity typically between 30 and 180 days, the duration risk is reduced.

The low tenor of the asset class offers investors a clear exit path and the opportunity to respond to changes in credit or rate conditions.

The portfolio-enhancing characteristics of trade finance don’t have to come at the expense of returns. Trade finance funds provide monthly or quarterly liquidity and target a floating rate of return at a profit over Libor, limiting investor exposure to rising interest rates.

As with any bond investment, credit risk or default risk always needs to be considered.

Trade finance lenders tend to have a priority claim, or lien, on the goods being financed. This strong asset security helps ensure recovery rates are high and default rates low.

Default rates for trade finance products from 2008-2018 averaged 0.36% for import letters of credit (LCs), 0.04% for export LCs, 0.73% for loans for import/export and 0.45% for performance guarantees, according to a 2019 report from the International Chamber of Commerce.

There are three further considerations investors should keep in mind when it comes to the current state of trade finance — which is subject to change in coming years.

Shipping costs: Higher freight costs due to increased container demand are making it more difficult for small and medium-sized suppliers to ship goods to their exports markets. Smaller companies exporting to the U.S. are often unable to take on the risk of trading in an unpredictable freight environment. This has led to a stronger uptake in the past year for trade financing as container freight rose.

Container shortages: Better consumer demand coupled with port congestion has impacted overall container availability moving between some markets/ports, impacting supply chains. Suppliers and buyers are working toward better forecasting models. Suppliers are also booking containers four to six weeks in advance to manage challenges due to container shortages. The Covid-19 story, today, is also well understood relative to 2020. Stakeholders are better placed to work around such issues.

Concentration in sector and buyer geography: In trade finance, it’s easier to get concentrated in a particular sector and/or one trade route like India to the U.S. or China to the U.S. Such concentrated exposures may increase overall portfolio risk. Trade financiers can mitigate this risk by working across multiple borrower relationships, sectors and geographies. This would help maintain a diversified portfolio of the underlying assets.

The current state of the yield environment has made trade finance an increasingly attractive asset class for investors looking for both income and portfolio diversification. Trade finance products offer a number of benefits that have become increasingly appealing in recent years, including short-term duration, floating rate returns, strong asset security, and low default rates.

While there are some considerations that need to be taken into account when investing in trade finance, such as concentration risk and the potential for container shortages, overall the asset class provides an attractive option for yield-seeking investors in today’s market.

Conclusion

The current state of the yield environment has made trade finance an increasingly attractive asset class for investors looking for both income and portfolio diversification. Trade finance products offer a number of benefits that have become increasingly appealing in recent years, including short-term duration, floating rate returns, strong asset security, and low default rates.

While there are some considerations that need to be taken into account when investing in trade finance, such as concentration risk and the potential for container shortages, overall the asset class provides an attractive option for yield-seeking investors in today’s market.

In conclusion, trade finance can offer risk-adjusted returns at low volatility and will likely have a valuable role to play in the broader private debt frontier and investor portfolios.

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