Letters of credit (L/Cs) feature in the growing number of trade finance funds that are emerging to meet demand from institutional investors seeking attractive returns with low correlation to stocks or bonds.

Trade finance funds have emerged to assume risks that banks either want to share or avoid altogether, which means they could be a key instrument in helping to close the widening trade finance gap experienced in emerging markets and by small- and medium-sized enterprises (SMEs).

Closing the gap

The funds are amongst several private credit solutions that have emerged to fill the gap left by banks retreating from various lending businesses as regulatory capital requirements have increased.

Estimates by the Asian Development Bank's measure the trade finance gap at between US$1.4 trillion and US$1.6 trillion, representing 8-10 per cent of global merchandise trade.

Investor focus

Trade finance funds usually comprise a range of financial instruments including L/Cs, performance guarantees, supply chain finance and import/export loans.

For investors, trade finance is attractive because unlike stocks and bonds it has proven resilient to geopolitical turbulence.

Growing funds

The Eurekahedge Trade Finance Hedge Fund Index increased by 2.78 per cent in the first six months of 2019.

In 2018, analysis of 15 trade finance hedge funds showed they gained 4.73 per cent, significantly beating their benchmarks and the overall global hedge fund industry.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.