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“May you live in interesting times” is believed to be an ancient Chinese curse. Boring, for them, was good. Take a look at today’s macroeconomic environment and it is anything but boring. This so-called Goldilocks Market will last only as long as the three bears don’t turn up. The geopolitical environment does not look as stable as it once was: Russia, Brexit, Trump, all have their role to play in shaking up previous certainties and turning them into uncertainties.
Investors have traditionally leaned on equities and public credit as a source of income and returns, but how much longer can that last? Stock market volume has been steadily declining, leading to less liquidity and more volatility. And the returns from the FTSE 100 aren’t looking very rosy over the last 10-11 years. If there is an under-researched area of concern, however, it is the credit market. The share prices of leading banks have never really recovered from the Great Financial Crisis: shares of Royal Bank of Scotland, for example, are down over 90% since the middle of 2007. The market value of most of the big banks has declined markedly in the last decade: Barclays alone has seen an almost 50% decline in its value.
New regulatory requirements such as Basel II are just adding to the grim reality for the commercial banks. This has also translated into a massive decline in net lending to private, non-financial companies. Closure of branch networks and a focus on lending via credit cards and mortgages has meant that UK firms are being starved of much-needed finance at a time when they are also facing rising costs.
The small business owner in the UK is now facing a host of new or rising expenses: the price of electricity is going up, waste disposal costs are mushrooming and the cost involved of employing personnel is also soaring. On top of this are the increasing long-term infrastructure investment needs of many businesses. For some sectors, strategically important sectors such as agriculture, there is a major question to be addressed: how to finance productivity for the food producing part of the UK economy at a time when the traditional finance lines available from banks are no longer available?
We have been seeing a rapid growth in private lending to SMEs in the UK over the last few years. According to the AIMA Journal, the private credit industry is on course to pass USD$1 trillion globally by 2020. European pension schemes, Middle Eastern sovereign wealth funds and Korean financial institutions, among many others, are supporting this ‘quiet revolution’ in modern finance.
The asset class has demonstrated its ability to achieve higher risk adjusted yields than many other traditional sources of income such as government bonds or corporate paper. This has not been difficult in the current environment of low to negative rates in most government bond markets. But it is also outstripping high yield bonds and syndicated loans. Direct lending brings much-needed finance to UK SMEs from non-traditional sources, but the lending activity itself is still managed by former bankers and commercial finance experts, the relationships are just as critical, but the end result is that SMEs can continue to receive the finance they so desperately need to meet the new challenges ahead.
Craig Reeves is the Founder of Prestige Funds.