- Cash provides high flexibility in terms of availability and purchase power.
- The costs of holding cash have meaningfully increased.
- Investors often overlook concentration risk and risk management in general for cash investments.
- There are ways to minimize the effect of negative interest rates, whereas a popular one is the “Liquidity Plus” concept, that targets to achieve a minimal positive yield, while accepting only very limited additional risk with daily liquidity.
Lending and taking security
We specifically like hard assets as collateral to secure a loan and identified the bridge loan market for real estate financing as particularly attractive.
Secured Lending describes loans, which are secured by collateral. We classify this type of lending as a sub-category of the private debt investment universe. The strategy unifies the benefits and attractiveness of a niche and specialized market. The strategy gathers an illiquidity and complexity premium while facing a reduced risk of losing capital as the loan is backed by collateral.
More general, a “secured” loan is backed (or secured) by an asset. Hence, the borrower pledges an asset (i.e. in our example, it is a property) as collateral in favour of the loan. In the event of borrower default, the creditor takes possession of the asset and sells it to recover the amount originally lent to the borrower (via a mortgage repossession procedure to get the keys of the home). Besides real estate, other assets can be used as collateral. Most common are hard assets such as aircraft, cars, machinery, equipment, inventories or commodities. Most liquid financial assets used are stocks, bonds or invoice receivables.
Residential mortgage loans
We have a specific focus on short term residential mortgage backed lending in the United Kingdom. We believe this strategy represents the sweet spot within the secured lending market as it 1) generates a high income of ~6-8% p.a., 2) is backed by a very strong collateral (homes with LTV* <65%) with extremely low historical loss rates, and 3) the maturity of the loans are short-term in nature at only 6-18 months. Hence, the strategy can be offered in a relatively liquid format.
* A loan to value (LTV) ratio is a number that describes the size of a loan compared to the value of the property securing the loan. Lenders and others use the ratio to understand how risky a loan is, and it can be used for approving loans or requiring mortgage insurance. A higher LTV ratio suggests more risk because the assets behind the loan are less likely to pay off the loan as the LTV ratio increases.
The chart illustrates the unique risk-/return profile of the strategy. An investor can structurally achieve an additional return, which we describe as illiquidity premium. We gain access to this asset class via a “clean”, closed-end fund structure with no asset-liability mismatch.
Short-Term mortgage market in the UK
The short-term mortgage market in the UK is estimated at GBP 4-5 bn annually. Since the financial crisis in 2008, stricter bank underwriting standards and requirements have resulted in more borrowers seeking short term finance via alternative lenders. The loan approval times have increased, due to strengthened regulatory guidelines for traditional lenders (banks), leaving limited options to those who require urgent financing other than from the short-term market. Hence, borrowers are increasingly reliant on alternative lenders. To enable borrowers to conclude urgent property acquisitions (often at a discount), credit decisions need to be reached quickly. This creates an opportunity to earn a premium rate by providing speed, the certainty of funding and the specialist services of alternative lenders.
“Trade Finance” finances the processing and shipment of goods and commodities from the supplier’s location (i.e. iron ore from Russia) to the location of the buyer (i.e. a foundry in Germany). These are typically cross-border transactions from one country or continent to another. The financing is performed via privately negotiated loans, a “lending format” that has historically mainly been performed by banks. However, over the last years, trade financing has substantially expanded into the private alternative lending sector. The attractiveness of such financing is that the loans are short term in nature and secured by a liquid collateral.