Asset finance funds – a low correlation alternative

Asset finance funds are investment funds that lend to smaller companies and other businesses rather than invest in public securities. They can also provide financing for other projects, for example the renovation or construction of infrastructure, or new energy generation facilities. Asset finance funds have been growing in size and importance as banks have cut back their lending activities in the wake of the 2008 financial crisis.

In practical terms, an asset finance fund will own a number of trading companies that manage the day to day lending activities and credit risks. Asset finance funds will tend to specialise in particular sectors or geographies, for example farming or alternative energy projects.

Asset finance funds have the potential benefit of low correlation to mainstream financial markets: because their underlying assets are loans secured against assets – e.g. high quality farmland – their returns are generated by interest from performing loans.

In addition, asset finance funds have the benefit of being transparent and easy to understand: investors can see how the returns are being generated, and the fund’s loans are secured against real assets. In the post 2008 credit environment, this brings an additional level of security and reassurance.

As banks retreat from day-to-day lending activity, and sever their direct lending relationships with clients, asset finance funds are stepping into the gap. Frequently, asset finance funds will be staffed with experienced personnel from the credit desks of major banks, with the sector lending expertise and relationships they bring with them. This is essential for a successful asset finance fund that wants to manage the loan portfolio properly and oversee client / credit risks.

Asset finance funds can also potentially enjoy indirect support from governments through awareness that lending plays an important social and economic role, regardless of the activities of commercial banks. Benefits to asset finance funds include being able capitalise on tax incentives or price subsidies (e.g. in the energy sector, helping the UK government to meet its medium term clean energy goals). Such subsidies are not available for public market investments.

Asset finance funds are very conservative in some respects, following clear lending criteria and procedures. They are team driven – their investment system is established from the beginning, and not dependent on ‘star’ fund manager talent. Consequently, asset finance funds have become very attractive for investors seeking superior yields to the bond market.