“It is remarkable…what a change of temper a fixed income will bring about”. Virginia Woolf, A Room of One´s Own.
Though few who practice our trade will admit it publically, the wealth management industry is immersed in an existential crisis. Quantitative easing by the world’s central banks has driven yields on high quality corporate bonds to near zero, and those of many sovereign nations to negative values. Traditional fixed income instruments are an essential tool of the wealth management industry and have been the mainstay of the classic “bonds/equities/hedge funds” asset allocation for decades. However, until yields rise from their current levels, government bonds and high quality corporate debt no longer add value to a portfolio. Rather, the fixed income allocation of a portfolio under current interest rate conditions adds credit and duration risk compensated by almost no return, or indeed a negative return.
If questioned as to why they persist in recommending traditional fixed income to their clients, wealth managers and asset allocators typically will state that “there is no alternative” as a justification for continuing to invest in this grossly overpriced asset class. It does not require a guru to see that market price and intrinsic value are clearly out of equilibrium in the fixed income markets, due to massive bond purchases by central banks and the increasingly frenzied search for yield by pension funds and insurance companies desperate to cover their future obligations. Even high yield bonds (formally known as junk bonds) now offer scant returns, as the hunger for yield overrides caution. From my point of view after twenty-five years of practice in the wealth management industry, to invest in an asset class that adds risk to a portfolio without providing return is tantamount to professional malpractice.
This being the case, where is a wealth manager to turn to secure attractive yields given the ongoing distortion of the traditional fixed income markets? Many wealth managers and family offices worldwide are turning to real estate as a substitute for fixed income, where rental yields replace bond yields. Investing in direct purchases of rent-generating properties as well as participations in real estate investment trusts and similar instruments is unarguably a reasonable move. However, I would suggest that many wealth managers are overlooking an alternative source of attractive yields that avoids the pitfalls of direct real estate purchase or participation in real estate funds, such as liquidity risk and exposure to real estate price cycles. This source is secured lendingfunds registered and regulated in the Grand Duchy of Luxembourg.
There is an astounding width and depth of credit expertise to be found among the management teams of many of the secured lending funds registered as Luxembourg SICAV-SIFs. Luxembourg is second only to the United States in terms of mutual fund assets, totaling over 3,500 billion euros as of July 2016 according to the highly respected CSSF, the Luxembourg financial regulatory authority. Although the majority of Luxembourg-registered assets are daily liquidity retail funds under the UCITS umbrella, there are over 1,000 Luxembourg-registered SICAV-SIFs. These vehicles are by their very nature a wealth management rather than a retail product, as they are intended for well-informed investors and are subject to the Luxembourg Act of 13 February 2007 on specialized investment funds, as amended. For this reason, they are subject to a minimum investment requirement of 125 000 euros. Liquidity varies, but redemptions and NAV declarations are typically on a monthly basis.
Since there is no equivalent of Morningstar to collectively track the performance of the SICAV-SIFs, a great deal of outstanding investment and credit analysis talent in this segment has not received the attention it deserves. For example, among the SICAV-SIF managers, there are secured lending funds specializing in each of the various segments of the asset-backed lending spectrum, including financing account receivables, specialized small business lending, aviation and machinery leasing, trade finance and real estate bridge financing. Though the particulars are different in each case, the common element among these successful secured lending funds is that they lend their investor’s capital to finance selected short term opportunities in the real economy, with a sufficient guarantee to secure the loan and protect the fund’s NAV in case of a default. These funds normally operate in creditor-friendly jurisdictions such as the United Kingdom or Germany where assets pledged to secure a loan can be quickly transferred to the creditor if a default does occur. In short, these funds operate in a terrain that once belonged to traditional merchant banks, but is increasingly abandonded by the banks as they restructure in the face of Basel III capital requirements.
Given this track-record and the ease of investment in Luxembourg SICAF-SIFs for wealth management clients through their securities accounts, I would encourage private bankers, family offices and wealth managers in general to begin to think outside the box of traditional fixed income and real estate to give serious consideration to Luxembourg-registered secured lending funds as a source of attractive, stable, non-market correlated returns.
Opinion column by James Levy, Director of Clearwater Private Investment.
