When Federated Investors launched late last year its first trade finance-focused interval fund, a surprise was in store for Robert Kowit.
His primary target for the Federated Project and Trade Finance Tender Fund was the very big institutional investors like pension funds, endowments, mutual funds and insurance companies that he assumed would have the deepest grasp of oft-misunderstood trade finance assets.
What Kowit hadn’t anticipated was that high net worth individuals in inland and southern US states – where an economic skew towards agriculture or energy means that for many wealthy families, trade is in the blood – would prove far more knowledgeable.
“The default setting for most people is that the bigger and more sophisticated a financial institution is, the more they must know about trade finance,” he says. However, “as you move in from the coast of the US, the family wealth that has been accreted over the years doesn’t depend on tech, it doesn’t depend on inheriting money from wealthy parents – these are families who have been involved in things like agriculture and exports for generations, and their familiarity with trade finance is probably greater than the supposedly sophisticated pockets on the east and west coast.”
A recent study by the Peterson Institute for International Economics, which identified which US counties would be most impacted in terms of job losses by the US pulling out of NAFTA, underscored the heavy dependence on trade of certain US states. The country’s biggest exporting state for example is Texas, where more than a million jobs are related to exports – not only of oil and gas but of manufactured goods – Kowit notes.
For many wealthy families in states like this therefore, the topic of trade “resonates much more at a grass root level than it does with a high-end chief investment officer at a foundation or endowment or pension fund.” For this reason, introducing the Project and Trade Finance Tender Fund and the assets within it required “a lot less explanation” when speaking to the registered investment advisors (RIAs) who manage family wealth than to many other potential investors.
The pools of money that some of these RIAs have available are also significant. Among Kowit’s circle of contacts, two RIAs that specialise in family offices – and which are located within blocks of each other in a Midwestern US city manage around $19 billion and $16 billion, respectively. Two more in southern US states each have around $18 billion.
But while there is now more than $20 trillion sitting in private wealth management globally, very little of this is invested in trade finance assets. “The supreme irony of that is the biggest managers of private wealth assets reside within the same banks that are major players in trade finance,” Kowit says.
As demand for trade finance rises however, more liquidity will become essential and the assets this produces will gradually gain ground with investors, Kowit predicts. Even conservative estimates have the value of global trade reaching over $100 trillion by 2050, with half of that likely to take place between emerging economies, he notes. “There’s no way that bank balance sheets are going to be able to meet the growing demand for trade.”
And while smaller self-sourced trade finance funds are going some way towards plugging that gap, most are essentially direct lending platforms made up of transactions that are not really bankable or attractive to institutional investors, he says. Some are also guilty of misrepresenting the true default risk in trade finance and this is bad for the industry, he argues.
That said, trade finance assets currently yield as much or more than leveraged loans with a much shorter credit duration and are made up of significantly higher-quality transactions in terms of their structure and security. “So for those investors that still have very large leveraged loan portfolios, trade finance represents and extremely powerful diversification tool within the floating rate space,” Kowit says, noting that Federated’s trade finance strategy has historically had a negative correlation with the leveraged loan market.
Concerns about rising interest rates will stimulate demand for trade finance assets further, he predicts.
Federated’s trade finance performance
Federated started investing in bank-intermediated trade finance transactions in 2006, with some of its international bond funds buying individual deals as an alpha source. In 2009, it created a pooled vehicle designed to be used by its domestic fixed income products.
Trade finance assets are held in each fund’s ‘illiquid’ bucket but must still be priced daily by an independent pricing source. They have generated gross annualised returns from inception through to Q2 2017 of 3.8%, with annualised volatility of around 1%.
Federated launched its Project and Trade Finance Fund Tender Fund in response to interest from smaller institutions and high net worth individuals seeking reasonable yield from a short-duration floating-rate strategy that was negatively correlated to other assets, Kowit says.
Initial ramp-up for the fund – which follows the same strategy as the much larger comingled vehicle and is expected to generate similar investment returns – took longer than expected. As a consequence, it experienced significant ‘cash drag’, or un-invested funds, he says.
As a so-called interval fund, it is structured as a continuously offered and closed-ended mutual fund. Its current net asset value is just under $100 million but it has no ultimate target size. The minimum ticket size is $100,000.
As of August 31, 2017, the fund’s one-month cumulative total returns before tax stood at 0.2% – double benchmark returns of 0.1% for the period. Its three-month returns also outperformed, at 0.57% compared with 0.27% for the benchmark. The fund’s 30-day yields stood at 2.34%.
Kowit describes the fund as “moderately successful” and credits its appeal among investors to Federated’s long-track record in the space – it has been investing in trade finance assets for its own funds since 2006 – and its reputation in the US as a “very conservative investor.”
“There’s a high degree of recognition in the market of the risks that are embedded in many of the other floating-rate strategies that investors seem to be looking for right now,” he says.
Any investor wanting to redeem money from the fund must give three months’ notice. Total redemption allowed in any quarter is capped at 25% and if more than this is requested the board will allocate on a pro rata basis. This means Federated should in theory never have any difficulty collecting cash to pay investors without having to sell anything, Kowit says.
The reason for those rules is that “cash flows in trade finance are very heavy, so our average maturities on the fund have run between 14 and 18 months,” Kowit explains. “So the combination of coupon flow and principal pay-down and maturities runs around 7% or 8% a month.”
We are set to return to this global trade hub and bring together a network of buyers, sellers, financiers and facilitators for another year of lively debate!