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Brexit, and the uncertainty it’s bringing, may mean no investment strategy can shelter investors from the from the storm…or is there at least one safe harbour still open?
Living in an uncertain world, we know there will always be bumps in the road. However, when people make simple claims, fail to execute on them and under deliver, we are clearly less forgiving when the bumps do arise. Whether you originally voted leave or remain or didn’t properly understand the consequences of the question at hand, I don’t think anyone is particularly happy with our political operators and the country’s current position. To say there is uncertainty is an understatement; no one knows what the 51% really meant when they said leave and ironically, giving people another vote is supposed to be ‘a betrayal of democracy’.
With politicians and decision makers still tying themselves in knots, and with a ‘meaningful’ or ‘indicative’ vote(s) not scheduled until about a scarily last-minute 10 weeks before Brexit, everyone needs to prepare for anything other than Plan A (not that anyone even knows what that is). As product providers, advisers and end consumers of financial services we need to take responsibility for our financial futures and those of our clients. This upcoming tax year end is a good chance to get affairs in order and to look at what strategies can help investors weather the storm.
At Goji, we believe investment into a newly available asset class, Direct Lending, can provide some respite from the volatility and downside risks presented by Brexit. Given it’s at the heart of what we do, it’s not surprising we believe in it – but it’s not only our view, it’s shared by institutions globally, which is why it’s been the fast growing asset class in recent years.
From our discussions with our lending partners and our ongoing portfolio diligence and monitoring, we believe our funds could be well positioned to guard against Brexit-related uncertainty.
Here are some of the reasons why:
Direct Lending providers (ie the non-bank lenders that assess and extend credit to borrowers) are not funded by short-term wholesale funding, such as repo market, nor do they typically issue bonds on public markets. If Brexit uncertainty or actions result in any downgrades to UK sovereign, financial institution, or broader credit market ratings, it will in turn hit public debt, banks, and funding markets. Therefore a lack of liquidity in funding markets could impact investors’ fixed income portfolios and mean banks stop lending to creditworthy businesses which is bad for investors, borrowers and the economy all round.
Crucially, none of this should have much of an impact on Direct Lenders. As Direct Lenders get funding from ‘Patient Capital’ (i.e. longer term retail or institutional funding), rather than from public markets they stable capital to finance lending with and therefore generate returns for investors. Businesses require stable funding and Direct Lenders can move fast in times of uncertainty and illiquidity to provide finance where and when it’s needed. This generates an attractive return to investors who are having the doubly virtuous impact of helping SMEs through difficult times.
Whilst there are some closed-ended investment trusts that represent a source of patient capital for some direct lenders, the value of shares in these trusts are a source of market volatility and therefore a source of contagion should confidence in public markets wane as a result of Brexit – not to mention any other sources of market volatility including the US-China trade wars, a slowing global economy and global monetary policy.
Investing directly in Direct Lending products, such as Goji’s Diversified Lending or Goji’s Renewables Lending portfolios can provide exposure to the benefits of Direct Lending whilst helping to guard against some of the risks of public markets. There are other risks involved however, and so investors should ensure they appraise themselves of these before investing.
Because investors in Direct Lending typically invest through private investments, (institutions through private equity style funds or retail investments in an IFISA) lenders know that their business models should survive periods of short term Brexit induced uncertainty or volatility. This patient capital can also be a source of comfort for other investors because they know investors won’t be running for the door at the first sign of broader loss of sentiment, and therefore Direct Lenders’ business models have longevity; returns can continue to be earned despite stressed market conditions.
The downside to the the illiquid nature of these investments means investors can’t access their capital as quickly, and this is why Direct Lending should only ever be considered for a small part of an investors’ allocation.
Investors in portfolios of Direct Lending assets are typically invested across multiple loans. This simple act of diversification helps protect against any one, or a small number of loans, not performing as planned and eroding investors’ capital. Some portfolios, but not all, are also invested across multiple sectors adding yet more diversification by protecting against any industry level risks.
Investments in Goji’s Diversified Lending Bonds are diversified even further because we allocate across multiple lenders, who work in different credit markets and in turn extend credit to different industries. Investors are typically exposed to over 1,500 loans, multiple lenders and multiple sectors.
This high level of diversification ensures investors are hedged against any individual loan, sector or lender being adversely impacted by Brexit or if any individual lender is adversely affected by Brexit.
Whilst traditional fixed income instruments can be 10, or even 50 years in duration, loans to SMEs, especially ‘Project’ or ‘Receivables’ can be extremely short term – as little as 30 days in fact. Across the portfolio of Goji’s Diversified Lending Bonds, the average duration is about 3.5 months.
This short duration not only provides a very attractive return for such short dated debt, especially when compared to public fixed income securities, but it also gives us the ability to frequently rebalance our portfolios and to manage any monetary risks such as interest rates or inflation.
Because capital is recycled so frequently, Goji is able to reinvest in the best risk adjusted opportunities that it considers are available to it at that point in time.
In portfolios of Direct Lending assets there is a natural level of liquidity provided by the cash flows of amortising loans. Every month, an amount of capital and interest is repaid and this cash can be used to invest in new credit assets that are best placed to mitigate the current risks affecting the portfolio, or to meet redemption requests from investors. This counters some of the challenges of investing in private, non-tradable investments.
The information contained in this blog is of a general nature and intended as guidance only. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial, legal or other issue. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult a financial planner/advisor to take into account your particular investment objectives, financial situation and individual needs