Fast reading
- Federated Hermes’ Trade Finance Strategy has a global investment mandate. We seek to maximise the benefits of portfolio diversification and generate higher potential risk-adjusted returns for investors – wherever in the world those opportunities may be.
- While the Strategy also invests in developed markets (DM), our portfolio of alternative credit assets typically has significant exposure to emerging markets (EM). EM boasts unique attributes, including the potential for higher returns, faster economic growth and access to commodities – yet they are fundamentally underserved in terms of access to credit.
- The case for EM credit investing typically focuses on growth and returns relative to economic fundamentals. However, EM also introduces jurisdictional, geopolitical and country-specific risks. By focusing on trade finance as a unique subset of the wider EM private credit universe, Federated Hermes’ Trade Finance Strategy aims to avoid (or mitigate against) many of those risk factors, without compromising the EM risk premium.
Federated Hermes’ Trade Finance Strategy invests in short-term loans that play a key role in facilitating global trade flows and their related infrastructure.
In contrast to strategies that invest in public credit markets, trade finance is not beholden to a fixed universe of issuers – instead it independently selects where and when to deploy capital, and which companies and projects to back.
While our Trade Finance Strategy is able to invest across both emerging markets (EM) and developed markets (DM), the sizable unmet demand for alternative credit in EM creates many more compelling investment opportunities compared to DM.
Incorporating EM into trade finance has numerous benefits
Over the last couple of decades, globalisation has led to a significant amount of industrial activity – and its related supply chains – moving from DM to EM. As a result, EM has significantly increased its share of global trade.
Between 2000 and 2019, the share of emerging markets in global trade increased from 32% to 46%, and its share of global foreign direct investment (FDI) rose from 15% to 46%. At present, the majority of the world’s GDP growth occurs in EM
Over the last couple of decades, globalisation has led to a significant amount of industrial activity – and its related supply chains – moving from DM to EM. As a result, EM has significantly increased its share of global trade.
Between 2000 and 2019, the share of emerging markets in global trade increased from 32% to 46%, and its share of global foreign direct investment (FDI) rose from 15% to 46%. At present, the majority of the world’s GDP growth occurs in EM1.
Figure 1: Trade between emerging economies on the rise
Many EM countries boast robust economic growth, supported by young populations and a fast-growing middle class, and these factors have transformed production and consumption patterns: EM has increasingly become a destination for – as well as an originator of – global trade flows.
Emerging markets enjoy unique attributes:
- Primary goods/commodities: Many EM countries are rich in natural resources and are leading producers of primary goods. EM economies play outsized roles across the value chain of key commodities such as oil and gas, metals and agricultural products.
- Solid fundamentals: EM economies have matured and are now more resilient to external shocks than has been the case in the past. The Strategy focuses investment on EM ‘national champions’ – borrowers that play an outsized role in an economy, with well-established businesses with strong balance sheets and operating track records. Many of these national champions enjoy unique competitive advantages and have become increasingly integrated into global supply chains.
- Underserved markets: The breadth of sources of finance available in DM are not usually available in EM. Since EM public markets are not as developed, availability of credit overall remains comparatively scarce. Bank-led financing is usually the primary source of credit and in the case of trade finance – a market subset – there is a significant shortage2.
- Potential for higher returns and lower default rates: On a relative basis, EM debt has historically offered higher yields and spreads in comparison with DM. Emerging market issuers have also reported corporate default rates typically below those in global high yield3.
Figure 2: EM debt has historically offered higher yields vs. DM
Trade finance supports the primary production of goods, and facilitates their movement along the value chain – both domestic and cross-border.
Trade finance has traditionally fallen under the remit of global commercial banks – with loan origination achieved through their extensive domestic and international relationship networks.
The Strategy’s approach is to operate alongside these banks, working together to deploy capital productively, rather than competing with them.
Our close links with leading banks allows us to benefit from their expansive loan origination networks. It’s a quid pro quo relationship, where we help facilitate solutions to regulatory pressures on capital and other constraints on banks’ balance sheets.
Where banks step back, our Trade Finance Strategy finds opportunity
Despite its obvious attractions, EM investing can also introduce exposure to jurisdictional and country-specific risks – such as geopolitical instability, less-developed regulatory systems and greater macroeconomic volatility.
Federated Hermes’ Trade Finance Strategy is designed to either seek to avoid (or mitigate against) many of those risk factors, without compromising the EM risk premium.
- Currencies: The potential risk to portfolio credit quality from fluctuations in the US dollar is effectively mitigated against by investing in hard-currency transactions.
- Documentation: The use of market-standard English and New York law-governed legal documentation helps mitigate against potential idiosyncrasies in EM local law. The incorporation of features such as the offshore routing of cash flows and advance waivers of immunity can help protect against non-payment risk and convertibility and transferability risks.
- Contractual risk mitigants: Traditional credit protections such as maintenance covenants, the use of offshore collateral, and placing restrictions on borrowers’ operational and financial flexibility, remain a key feature of EM trade finance loans (even with higher-quality borrowers).
- Selective and adaptable investment mandate: The Strategy navigates potential concentration risk by applying rigorous diversification across its investment portfolio. Investments are not exclusively tied to any country or region, or any specific industry or originator. All transactions are selected for investment following careful analysis of their standalone merits. The Strategy is highly selective and focuses on established leaders in their respective industries – businesses that have a distinct and compelling competitive advantage (regardless of where they operate). For such businesses, we provide senior capital linked to specific trade activity or to capital projects of significant strategic importance (as opposed to providing generic blank cheque corporate funding).
Federated Hermes’ Trade Finance Strategy provides alternative credit globally, on a highly selective basis, utilising robust financing structures that are of strategic importance to the parties involved.
In underserved EM capital markets, the Strategy is able to pick and choose where to provide flexible solutions, which can result in attractive risk-adjusted returns for investors.
EM in Trade Finance Report
For more information on Trade Finance.
Share:
1 Emerging Markets Network | OECD
2 The gap for global trade finance opportunities was valued at US$2.5tn by the Asian Development Bank in 2022, up from US$1.7tn two years previously, and is forecast to continue widening, according to the Asian Development Bank.
3 S&P Global Ratings: 2024 Annual Global Corporate Default and Rating Transition Study; 2024 EM and Frontier Markets Corporate Default and Rating Transition Study.
BD016149
