Trade Finance

Reasons to invest

Alpha generation

Inefficiencies exist for non-bank investors and can be consistently exploited.

Uncorrelated returns

Low-to-negative correlations with most major market indices.

Diversifier

Reduces reliance on traditional return drivers.

Originate-to-hold model

Banks have ‘skin-in-the-game’ by retaining significant portion on balance sheet.

Unique access

Financial investors can participate in global trade growth, traditionally the domain of commercial banks.

Quick links

Overview

Trade finance is basically a sub-set of the loan market. It is relatively short-term loans used to finance the physical flow of goods, using those goods as the primary source of collateral within the loan.

Christopher McGinley

Senior Vice President, Head of Trade Finance

Why Trade Finance?

Uncorrelated returns

Facilitates physical cross-border transaction

Vital role in supply chains

Trade finance can potentially provide an opportunity for investors to access uncorrelated alpha with limited reliance on traditional return drivers.

Short-term loans to facilitate physical cross-border transactions can reconcile the divergent needs of an exporter and importer.

Trade finance has a critical role to play in addressing snags in global supply chains and ensuring that vital commodities continue to flow.

Investment philosophy

Federated Hermes’ Trade Finance Strategy offers investors the potential for a source of uncorrelated return, with low volatility and high return that adjusts with inflation. Trade Finance is an asset class that requires specialised experience including intensive legal and operational due diligence, a deep understanding of risk and how to mitigate it, and relationships with the largest global banks. We believe that as the worldwide demand for trade continues to grow, a diversified pool of trade transactions will consistently deliver the ‘pure alpha’ that investors seek.

Investment process

Trade Finance refers to loans that are made to finance a specific trade transaction. The loans are collateralised by the goods being financed and are self-amortising from the proceeds of the transaction. The loan rates float at a spread over a short duration index, allowing for adjustment to inflation and the lenders build risk mitigants into the deals to reduce the chance of loss.

Highly selective

Sourcing

Deals are typically sourced through global banks, specialised insurance companies or traders. Federated Hermes’ initial due diligence includes an analysis based on the following investment criteria: type of financing structure, reputation of arranger, strength of obligor/guarantor, pricing, risks, and compliance with investment guidelines and the current portfolio.

Screening

Detailed due diligence

Once the decision to move forward is made, detailed due diligence is performed based on five quantitative and three qualitative factors:

Quantitative factors

Origination: Assess quality and track record of originator, define originator’s role in the transaction and define originator’s relationship with the borrower
Obligor: A thorough review of obligor including but not limited to credit analysis, shareholders, market position, access to capital markets and quality of audit/accounting firm
Country: A country’s credit rating, historic treatment of trade flows, the importance of the sector to this country and currency convertibility
Sector: Evaluated for: Strategic priority, critical imports, FX earner, macro sector themes, and liquidity and tax/tariff issues
Mitigants: The proposed deal is also evaluated for: production, operational and payment issues in addition to commodity, price, environmental, country and legal/documentation considerations

Qualitative factors

The structure and pricing of the deal are closely analysed with consideration of the portfolio’s yield target, concentration, and tenor.

Deal structure: Tenor, grace period, amortisation schedule, drawing conditions and financing structure
Deal pricing: Relative value of spreads to market, value for risk and return projections
Portfolio: The tenor, yield target and concentration of the Trade Finance portfolio: Concentration analysis includes region, country, sector and obligor structure.