How Federated Investors invests in Trade Finance Assets

Louis: Looking good, Billy Ray!

Billy Ray: Feeling good, Louis!

Trading Places (1983)

Trading Places was one of my all-time favorite movies. I mean the Dukes and their social experiment, the smug Louis who the Dukes royally, well you know what, and of course, the belovable Billy Ray, that showed how understanding psychology of markets was more important than understanding market trends.

So what does this have to do with Federated Investors and Trade Finance. Alpha, yup, Alpha. As Federated likes to say, trade finance provides an uncorrelated source of alpha in a low-yield environment or as Billy-Ray would say, if others are panicking, you should be buying.

Federated has been successfully investing in trade finance assets since 2006 and currently manages approximately half a billion USD, which is still a tiny amount relative to the $360 odd billion of assets managed.   The majority of invested funds under management (US$259bn) are money market investments with the remainder split roughly evenly between fixed-income (US$53bn) and equity (US$51bn)

But just what are they buying? And if they have been doing it for 10 years, why haven’t others figured this out? I mean, copycat is a form of flattery, and in the brutal business of investment returns, it’s every man for himself.

I mean we all know the attributes of trade finance that make it attractive, and I am not going to go into that here – things like emerging market yields, short term, self-liquidating, collaterized and risk mitigated, low defaults, etc.   For example, Trade Finance risks can be mitigated by techniques such as hedging, collateral management of the goods, permanent control of the title over the goods, ring fenced cash flows, and trade credit insurance.

So just what does Federated invest in? In 2005, Federated began to buy individual trade finance deals into some of its international bond funds.  Essentially they don’t do their own origination, but depend on banks that have a presence in the market where the deal is being originated. They are investing in structured trade finance deals originated by banks.  Examples could be Mongolian copper, or Angolian scrap iron or Ukrainian steel deals.  These structured trade finance deals typically have production risk or the risk that the copper mine has a national strike, or that Angolia falls into a civil war and ships cannot get into or out of port.  Internally, Federated treats trade finance as an illiquid asset and all Federated Project and Trade Finance investment strategy holdings reside in a fund’s illiquid allocation bucket

For example, in the course of a given year Federated might see 600 to 800 discrete deals and make investments in only 80 to 100 of them in their fund.

To do these deals you need a team that has good relationships with the bank and other originators and can assess the underwriting done by the banks. In addition, the need for custody, settlement, and documentation are high in these deals and provides a high barrier to entry. Once you get to critical mass it becomes scalable.  Once you been through the problem and challenges in a Brazilian Soybean transaction or a Mongolian copper transaction, than it becomes recognizable.

For most investment professionals, if it’s not on Bloomberg, it doesn’t exist.   But for those fund and asset managers willing to invest in the capabilities, this can be a fruitful area. There is no shortage of capital that is needed in these emerging markets.

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