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As international trade continues to grow as a key driver of global GDP growth, so too does the need for financing. Trade finance is a type of funding that helps businesses cover the costs associated with shipping and trading goods internationally. While large businesses and trading companies have typically had no problem securing financing for their trade activities, small and medium-sized businesses (SMBs) have often been left out in the cold.
This is where alternative finance providers have come in to fill the void. These data-driven fintech firms are agile and able to provide financing to SMBs that traditional lenders may not be able to service. And because these newer players have been successful in originating high volumes of creditworthy receivables, they are now an attractive investment opportunity for institutional investors.
So if you’re an SMB in need of trade financing, don’t despair – there are plenty of options available to you. And if you’re an investor looking to get involved in the space, trade finance receivables are definitely worth considering.
The Return Of The Trade Receivable
In recent years, there has been increasing interest in trade finance receivables as an asset class. This is because they offer yields significantly above Libor, as well as short duration and consistent returns. Additionally, exposure to multiple underlying commodities, finished goods and geographies lends strength to this asset class through diversification.
As a result of all these qualities, the number of trade finance-focused funds globally has grown in the past decade. These funds have opened the trade finance asset class — long considered accessible only by banks and large qualified institutional investors — to all private credit investors.
If you’re looking for an investment with low risk and the potential for high returns, trade finance receivables are definitely worth considering.
Covid-19 Impact
As the global economy begins to recover from the Covid-19 pandemic, trade finance will play a crucial role in ensuring that trade continues to flow smoothly. According to a paper published by the International Chamber of Commerce, it is estimated that $1.9 trillion to $5 trillion in trade credit will be required in order to return global trade levels to their pre-pandemic levels by 2021.
Of this total, it is believed that $0.8 trillion to $1.9 trillion will come from bank-intermediated financing options such as letters of credit and guarantees. This leaves a funding gap of $1.1 trillion to $3.1 trillion which will likely be filled by alternative finance lenders. As a result, we can expect to see a rise in trade finance receivables in the coming months and years.
For many investors, the idea of investing in global trade can be a daunting one. There is a lot of information to process and it can be difficult to know where to start. However, there are now specialized investment vehicles available which provide expertise and transaction portfolios for those interested in this area. So whether you’re a seasoned investor or just dipping your toe into the world of trade finance, there are options out there for you.
Analyzing Trade Finance Investments
When conducting due diligence on any investment opportunity, it’s important to understand the key risk factors involved. With trade finance assets, there are three main factors to consider:
1. The asset itself – What type of trade asset is it (pre- or post-shipment, for example), and what credit enhancements are in place? Are there any foreign exchange risks to take into account?
2. The structure – How is the entity where the trade asset is held structured? What are the liquidity terms and first-loss protections?
3. The firm – What is the experience of the originator, and what risk and credit management frameworks are in place? What is their track record like?
By taking these factors into account, you can get a better understanding of the overall risk involved in the investment. For example, if you were to invest in a portfolio of trade assets focused on China receivables from one exporter, selling one type of product (luxury goods) to one buyer overseas (a luxury retailer in the U.S.), the security may have performed poorly during the early days of the coronavirus outbreak in Q1 2020 given disruptions in the supply chain and underlying health of the one exporter and one buyer. Hence, diversification within trade assets is important.
A Rising Asset Class
The global financial crisis of 2007-08 left many banks reluctant to enter the trade finance space. However, with the outbreak of Covid-19, the demand for credit has grown once again. Traditional investments, such as U.S. Treasury securities and government and prime money market funds, have seen falling yields in recent years. This has created a surplus of liquidity and an increased need for portfolio diversification among investors. Trade receivables offer short-term returns, competitive yields and low correlation to more commonplace investments and the market. As such, they are well-positioned to meet investor needs and continue to grow in popularity as an asset class.
