In this fourth installment of a six part survey of market lending from the investor´s perspective, I would like to draw the reader´s attention to trade finance, a little known, but very attractive area of market lending. Trade finance is the short term financing of transactions between buyers and sellers, particularly international transactions. Trade finance investing is neither the most easily understood area of market lending, nor is it the most accessible to investors. However, I believe that it is worthwhile to make the effort to learn about this particular corner of the larger overall receivable finance market – which was covered well by Barry Rodgers in his recent Altfi Investor Blog, “Invoice Trading Platforms: Great Opportunities?” Trade finance has become an essential part of my market lending tool kit to help investors achieve worthwhile, steady returns for my investment advisory clients independently from the stock or bond markets, along w
Why does trade finance merit consideration by market lending investors? The following are the most significant reasons:
- Trade Finance has an extraordinarily low default rate. I cannot agree more with these words from the great American sage and writer Mark Twain, “I am more concerned about the return of my money than the return on my money”. It is a simple fact that it is much easier and faster for investors to lose money than it is for them to earn a return on their money. For market lending investors in loans, defaults are a great danger to the health of their savings. When it comes to investing in trade finance, this concern is greatly reduced. According to data from the International Chamber of Commerce, over the past 15 years, overall defaults on trade finance operations were approximately 0.5%.
- Trade Finance is resilient to crisis. One of the most frequent objections I receive from potential investors in market lending is that to a very large extent the whole field is so new, that there is no track record of how the sector would perform in the case of a major global financial crisis such as that of 2007-2008. This is a valid point that merits serious consideration, however, in the case of trade finance, the data from the International Chamber of Commerce shows that even during the financial crisis of 2007-2008, only 445 international trade defaults were reported out of 2.8 million transactions conducted during this period. The reason is that even as the financial markets were experiencing extreme turbulence, and the leading economies fell into a severe recession, world trade continued to function, particularly for commodities. Ships of oil, wheat, coal and iron ore continued to move from sellers in producing countries to buyers in consuming countries, and those shipments were financed, as they have been for hundreds of years, by well-defined trade finance procedures. Let’s remember that a trade finance operation (unfortunately, gone awry with the sinking of the uninsured ships) lies at the heart of the plot of Shakespeare´s “Merchant of Venice”. Even in the most extreme case where an entire country has entered into default, the leaders of that country would have every incentive to be sure that trade finance obligations are completed, thus permitting supplies of food, fuel and other basic necessities to continue to arrive to ports.
- Trade finance operations are secured. Funds advanced to finance the shipment are typically guaranteed by the goods of the shipment itself, and can be further assured against loss in the case of failure to pay the loan in a timely manner by additional guarantees signed by any combination of the buyer’s, seller’s, associated banks’, or even the personal assets of the party that receives the trade finance loan.
- Trade finance operations are short term. Typically, trade finance loans are between 30 to 90 days, and almost never exceed 120 days. In this way, a portfolio of trade finance loans is self-liquidating, that is, even though there is no secondary market for trade finance loans, an investor in trade finance knows that in a very short period of time the loans of the portfolio will mature if funds are needed for other purposes. Additionally, the short time period allows the same capital to be deployed many times during a one year period in a number of different loans, similar to a farmer in a tropical region where several harvests a year can be achieved. This rotation of the capital contributes to the very attractive historical annualized returns achieved by trade finance investors.
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