Are direct lending funds low correlation investments?

Low correlation investments are investments that do not perform in a similar way to other markets. Low correlation investments should provide returns independently of mainstream public markets such as stocks or commodities. For example, during a sustained bear market, low correlation investments should not follow other markets downwards.

Given that we live in an increasingly globalised world where geographical diversification does not provide the same protection it once did, investors look to new approaches to investment finance, including those underpinned by real assets, to protect themselves from market downturns. Low correlation investments are becoming more valued as investors become more uncertain about other traditional safe havens, such as government and blue chip corporate debt.

What makes a low correlation investment? A good example would be a fund investing outside traditional public markets. Loan funds and direct lending strategies have emerged as an excellent case study: these are funds which own trading companies that in turn provide financing for small businesses or infrastructure projects. They do not trade shares or own property directly. Instead loans may be secured against real assets, such as a bio gas project or prime UK real estate.

Low correlation funds are frequently used by investors for their diversification benefits. In addition, they often pursue investment strategies that are transparent and easy to understand. Loan funds, for example, are managed using established commercial finance criteria similar to those employed by finance companies and banks. They will typically own one or more financing companies that carry out the day to day lending and risk management criteria. Such financing companies will typically be staffed by experienced personnel drawn from the commercial banking or financing sectors who able to execute and manage a professional loan book on a day to day basis.

As markets become more unpredictable, large scale investors such as pension funds and insurance companies are turning to low correlation funds to help them to spread their risk and provide more consistent returns. Much obviously depends on the strategy employed by a low correlation fund: some are designed to only perform well in bear markets.

Direct lending funds now form a larger and more important part of the overall alternative investment universe today, thanks to their low correlation to the mainstream financial markets.