In search of Profitability and Liquidity in Alternative Assets.

The social crisis of October 2019 led to structural changes in the portfolios of high-equity investors, which were heavily concentrated in local assets. That is why, in search of further diversification, it was observed a high level of migration to financial assets outside Chile to minimize country and exchange rate risk. But the new balance did not only bring about a change in currency and geographic location weightings but also a strong short-term asset weighting was observed, a trend that increased as a result of the Coronavirus pandemic. Some of the reasons for this premium for liquidity are that many companies or businesses may require capital injections in the short term. Political instability or opportunities to arbitrate various financial instruments are other causes.

On the other hand, it is important to mention that, in the wake of the health crisis, various governments and central banks around the world have implemented a series of packages and stimuli through expansionary fiscal and monetary policies to maintain liquidity in the markets and thus keep the economy up and running. It is not uncommon, then, to see that the Monetary Policy Rate of Chilean Central Bank and other reference rates such as the TIP (average rate of placement of short-term of banks) are at their historic low, dragging down fixed-income returns and other short-term financial intermediation instruments, such as 30- and 60-day term deposits, now at near 0% nominal yields.

In this context, liquidity management has become one of the main challenges for investors in the short term. This increased demand for short-term assets has also challenged alternative asset providers, which, while characterized by higher returns, have a longer-term horizon.

This situation has led to innovation by the investment teams of different fund managers so that they can find a combination that offers attractive returns on private debt, but with the liquidity of public debt assets. That is why we have seen a strong increase in the market for various private-debt funds that have invoices as their sole underlying security, which are characterized by their short duration (30 to 60 days). But that is not the only feature of invoices, they also allow for a proper diversification by debtor and source of payment, achieving atomized portfolios, where the average invoice is less than 10 million pesos.

However, given this new offer of short-term private debt funds, what is the important thing to consider when investing?

The first thing is to understand the level of risk in the portfolio of invoices, and to do this you need to know who the debtors are. Usually, invoices are associated with small and medium-sized companies, but what matters, and what the investor should prefer, is who pays the invoice and not who issues it. A portfolio made up of government payers, such as municipalities or state mining companies, today has a lower risk than a portfolio made up of tourism-related companies, for example. Another very important issue to keep in mind is what happens if the debtor fails to pay, who is next in the row? Some investment funds, which are providers of financing for factoring, sign a liability agreement, whereby they pay the invoices in case the debtor fails to do so. This is the second source of payment that substantially improves the risk of the investment instrument. In addition, it is very important to know the policy of provisions of the portfolio and its percentage of delinquency among other indices.

There are also funds in the market that offer a preferential series for investors. The fundamental advantage of this is that investors can receive a preferential return, which is paid first, and therefore it is the residual series that assumes the first losses of the portfolio, if any. This could be considered as a third source of payment in the event of a debtor’s default. The higher the coverage level of the residual series, the safer the investor is. Another advantage of a preferential series —depending on how it is structured— is that it may have a fixed preferential earning, which allows the investor to know in advance what the return on his investment would be, and to be able to better program the use of funds.

Another key issue that emerges from the previous point is the liquidity of the fund. It is of little use an investment fund that is intended for the administration of liquid resources if it does not contemplate an appropriate redemption policy or alternatively it has a deep secondary market. Here is one of the most important secrets to achieving performance and liquidity from a single instrument.

While the analysis to be carried out before investing in a fund of these characteristics should be much more extensive, these are the main points to start from.