Trade finance needs are increasing, driven by recent supply chain disruptions and a tightening of bank financing.
The scale of the disruption to global trade over the past two years – including the impact of Covid-19 and geopolitical tensions – means that there is significant demand for this funding mechanism, which bridges the gap between the delivery of products and payment. According to the most recent estimate from the Asian Development Bank, the global trade finance gap has widened to USD 1.7 trillion in 2020.
Small and medium-sized enterprises need help the most, as some banks, the main traditional providers of trade finance, have reduced the availability of finance in the wake of the pandemic.
The impact of trade disruption can disproportionately affect the world’s poorest people, given the vital role trade plays in reducing poverty by creating jobs and driving economic growth.
Institutional investors looking for diversified assets can help by investing in trade finance. In return, they can access the complexity premium that the asset class offers.
How does trade finance work?
Trade finance is similar to a line of credit from a third-party financier that helps businesses finance the purchase and sale of goods. For example, it allows suppliers to receive money immediately, although their buyers don’t have to pay until some time in the future. Trade finance can be divided into four main categories:
- Financing payable – accompanies a buyer by facilitating payments to its suppliers when issuing invoices.
- Funding receivable – provides money to a single supplier before he receives bill payments from multiple customers.
- Working capital – grant loans to a supplier reimbursed by receivables from several customers.
- Documentary credits – common instruments used by companies to finance specific trade flows and payments under commercial contracts, including letters of credit, bills of exchange and commercial loans.
Why is trade finance a potentially attractive option for institutional investors?
In an environment of heightened geopolitical tensions, volatile bond yields and rising inflation, trade finance can provide the flexibility and potential returns needed to help investors weather the uncertain global outlook.
Its short-term maturity profile—typically, transactions have a life cycle of between 60 and 120 days—and its potentially low correlation to other asset classes can help investors manage an interest rate environment. rising interest. Investing in trade finance can help investors manage downside risk as it tends to exhibit low volatility, as was the case during the recent turmoil that rocked public markets.
The asset class can also help investors achieve their long-term sustainability goals. Since international trade is an engine for inclusive economic growth and poverty reduction, trade finance can be an important tool to achieve the United Nations Sustainable Development Goals.
At the same time, structural changes are paving the way for institutional investors to enter the market. Banks are looking for partners to meet their customers’ needs as they struggle to meet growing demand due to regulatory capital requirements. Meanwhile, fintech companies have brought innovation to the field, reducing unit costs and making small volumes of funding economical.
How can trade finance fit into a repo portfolio?
As pension fund investors look beyond the main asset classes to diversify return streams in a low-yield environment, trade finance can offer an attractive diversification option:
- The asset class can serve as an alternative to traditional credit assets such as asset-backed securities (ABS) and short-dated investment grade bonds due to potentially increased yield aided by a complexity premium.
- Similarly, trade finance can replace holdings of government bonds because it offers the possibility of stable returns and low sensitivity to rate changes.
- Finally, trade finance can also serve as a strategic cash position. Its semi-liquid structure gives investors the flexibility to move or reallocate portfolios. This ensures that trade finance can provide a potential funding source for private market capital calls.
Although it is a relatively new and complex asset class, with the right partner it is possible to take advantage of the potential benefits offered by trade finance.
To find out how Allianz Global Investors’ trade finance offering can benefit institutional investment portfolios, Click here
This position is funded by Allianz Global Investors
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