Does it make sense for treasurers to develop an investment strategy that incorporates short-term payables and receivables from the global supply chain? Guy Brooks, Head of Distribution for Working Capital Finance, Pemberton, certainly thinks so. He explains the treasury opportunities to TMI.
The short-term payables and receivables of large- and mid-market US and European corporates are typically framed as having a low default probability. With attractive returns relative to public markets, and zero duration risk, global supply chain finance (SCF) as an asset would seem like a good fit for corporate treasury cash. It’s certainly how Pemberton, a $13.5bn private debt manager for institutional investors, sees the working capital finance market developing.
Its MD, Brooks, has more than 25 years’ prior experience with Deutsche Bank Group under his belt. During that time he has seen many investment trends come and go in the fixed income, credit market, and trade finance spaces. It is the latter in particular that today catches his eye.
Financing the cross-border movement of goods brings a wide spectrum of financial products to market. These range from the short-term payables and receivables of the working capital space, to long-term solutions such as structured commodity trade finance with tenors of up to five years, and export credit agency (ECA) finance, which in some cases may stretch to 15 years.
With the continued globalisation of trade, and volumes showing no signs of slowing (pandemic-driven damage excepted), the global trade finance market size, valued at $44,098m in 2020, is projected to reach $90,212m by 2030.
It seems like a bountiful area for its predominantly bank-led stakeholders. But in the same way that many banks started pulling back from sub-investment-grade financing in the direct lending space a few years ago, so today they are retrenching from trade finance, notes Brooks.
Filling a gap
Trade finance has an historical dependence on banking. As banks step aside – often citing regulations, capital treatments, or cost-cutting in their exit statements – so a gap in the often highly dispersed field of sub-investment-grade lending has appeared. Recent estimates suggest there is a $1.7tr. hole in trade finance. This, says Brooks, presents an opportunity for alternative investment providers such as Pemberton.
With funds covering insured and uninsured credit risk in the working capital finance space, Pemberton’s aim is to leverage the global short-end of the market, typically of 90 to 180 days tenor. Industry sources suggest it currently has around $670m AUM, with an equal split in its portfolio of underlying trade risks spread between Europe and the Americas (Asian risk is on the cards). The firm also reportedly has an ambitious target of more than $1bn AUM in the next three months.
The assets it buys are freely transferable SCF deals. These are brought into a fund in which investors can purchase shares. In doing so, they create exposure to the underlying trade instruments, which are usually originated by banks, and subject to robust bank risk analysis, with some assets also flowing from trade finance platforms, and in a few cases being originated directly.
For an asset manager to acquire the right assets, it too has to apply robust credit analysis. This is usually undertaken either on an individual corporate that it wants to take into its portfolio, or if it has significant trade from smaller businesses, it can take a statistical approach, looking at common aspects such as sector and geographic performance. Pemberton takes the former approach, its own credit team applying fundamental principles informed by a bank-derived analytical model.
The assets that are brought into Pemberton’s portfolio are held, not subsequently offloaded as part of a secondary market. Each risk component is regularly monitored, and if for some reason the team is not comfortable with the performance, the short-term nature of the underlying instrument means it can simply refuse to take on the next batch of invoices of the underlying business.
Safe and sound
While there will always be non-performing loans, Brooks says he has seen no defaults in any of Pemberton’s portfolio since its inception, even during the worst of the pandemic. It’s in part a testament to the credit analysis team, but he feels that it’s also a reflection of the market as a whole. “The default rates within the asset class are incredibly low. It is a stable and secure.”
Yet this is an asset class that remains “relatively untouched” by the investor community. With the gap created by the exit of some banks from this space, “an opportunity of size and scale” has emerged that previously was not available, says Brooks. “The banks will continue on their exit path, which will see that funding gap expand as global trade itself continues to increase,” he notes. “This has already been seen in the commodity market with the recovery of prices; the requirement for financing in this sector is huge and growing.”
With evidence of a large and scalable market presenting increasing opportunities for investors, the relative values at play are interesting. “The average rating of our portfolio is BB or BB+,” says Brooks. “The returns for investors are around 250 to 300 basis points over Libor, uninsured, and for credit-risk insured assets, giving an implied rating of A-, the return is still 100 to 125 basis points over. To achieve the same returns on a like-for-like rating in the bond or loan market would require the investor to go out to four or five years.”
Currently, the investor universe within this asset class encompasses a broad sweep of institutional investors. For corporate treasurers, while investment may require policy amendment, this market presents a short-term, high yield, credit play in an open-ended fund that offers monthly or quarterly liquidity. “One way of looking at it would be as a cash-plus solution,” comments Brooks. “For corporates managing their short-term liquidity, it’s another way of getting a yield pick-up on their bank deposits or money market fund investments.”