Ferguson Hyams Investment Management FHIM Trade Logistics USD 4.5% 2025 Bond
IAM Capital Markets View
In our view, this would be a very low risk within the non-investment grade space. The Fund’s main activity is trade financing, which is a lower-risk asset class than SME and bank lending respectively. It has similarities to the residential mortgage market, with risk marine insurance policies kicking in to cover any loss in the value of the goods.
The Fund does not take direct credit exposure, with the main risk being commodity price declines if the Fund cannot recover the full purchase price on an asset. The Fund’s performance has been exceptional, even throughout COVID-19. Indicative of its superb risk management, the Fund has achieved a historical buyer default rate of 0.00% across over 700 transactions.
There are not a lot of comparables in this sector. However, from a relative value perspective, the yield of 4.5% is around 150bps wider than the USD single-BB credit-rating yield curve in Chart 6. In the unrated and rated high-yield space, it looks fair value to the comparables in Chart 7 when factoring in an illiquidity premium. Investors would want to be mindful of the lack of liquidity in this line and should consider it as part of a diversified portfolio.
The Investment Strategy
- Investors gain diversification within the fixed income space to trade finance, outside regular bond issues from the banks and property A-REITs
- Trade finance is a low-risk asset class with historically low default rates and high recovery rates/recovery times given the asset-backed and fungible commodity nature of financing
- Similar to residential mortgages and lenders mortgage insurance (LMI), trade finance utilises risk marine insurance policies to cover any loss in the value of the goods
- Bondholders (via Underlying Bond) effectively have protection by ranking senior to equity unitholders in the Fund
- From a relative value perspective, the yield of 4.5% is around 150bps wider than the USD single-BB credit-rating yield curve
Trade finance activities relate to short-term, asset-backed transactions between 15-120 days that are completed via traditional finance instruments (letters of credit, bank guarantees, and bills of lading) through a Fund.
The Fund generates a return by simultaneously executing a buy and sell contract and taking a positive margin between the two contracts. This margin reflects the implied balance sheet cost charged for holding the commodity. The Fund then provides transport of the cargo, taking ownership of the asset, at the place of port. This means the Fund is not exposed to the credit risk of the purchaser – although exposure to commodity price risk is triggered by the buyer defaulting.
Chart 1. Trade Finance Default and Loss Metrics
Source: International Chamber of Commerce, calculated for 2008-2018
Risk marine insurance policies limit the loss in the value of the goods. A key part of the trade financing strategy is using insurance policies to cover the risk of physical damage to the commodities during transit and storage. This improves expectations of recovery in both idiosyncratic and systematic-type risk possibilities. All risk marine insurance policies are undertaken from an A (or better) rated insurer.
Additionally, it will bear transaction costs in relation to finding a secondary purchaser, executing the contract, and costs of storing or warehousing the commodity due to the delay. These risks are partially mitigated by the Fund demanding a Trade Facilities Fee (TFF) calculated as a portion of the purchase price from the buyer before transit. This fee will cover the transaction costs of the secondary contract and provide a buffer margin to cover any commodity price decline. The minimum TFF is 10% and there is no maximum. However, during COVID-19, it was as high as 60%. On average the TFF is 20%. This is almost analogous to a prepayment on a residential mortgage.
The Fund has an exceptional track record in its risk assessment, with a historical buyer default rate of 0.00% across over 700 transactions. The transaction size is typically in the range of USD200,000 to USD3m, with an average of USD370,000 as at April 2021.
Using a $100 Cargo Example
Two examples of what happens if there is a default Issue A or when the buyer walks Issue B.
|Issue A: Insurance is always risk marine insurance from an A (or better) rated insurer. This covers 100% of the cargo, should the boat sink, the cargo is damaged or partly lost, etc.||Issue A: If the cargo is lost, risk marine insurance pays 100%.|
|Issue B: The Trading Facilities Fee (TFF) or prepayment is calculated with reference to the required P&L and the spot price at the destination. This allows the Fund to buy the cargo, knowing that if the buyer defaults, they can offload the cargo at the destination port in the spot market and not adversely affect its P&L.||Issue B: If the buyer defaults, that event is not insured (its collateralised by the cargo). Thus, the cargo is sold in the spot market at the destination port, however it is “owned’’ at a 20% discount (based on average TFF).|
Chart 2. Fund by Sector and Commodity
Chart 3. Fund by Delivery/Storage Location
The Fund has consistently delivered target returns to unitholders of 5% net of all fees. Especially notable is the performance of the Fund through COVID-19. A core feature of the Fund is the lack of correlation to broader markets.
The monthly returns of the Fund exhibit minimal correlation to domestic and international equity, commodity, and credit markets. Over the past three years, the Fund did not have a correlation coefficient above 0.40 for any major index and recorded a negative coefficient for a number of major credit indices.
Chart 4. Monthly Return Correlation Matrix
Chart 5. Underlying Fund Monthly Net Returns* (%)
* Return is a monthly net total return based on NTA plus dividends.
Source: BondAdviser, Underlying Manager. As at 31 April 2021.
Ferguson Hyams Investment Management (FHIM) is the investment manager on this Fund and focuses on generating returns with low or negative correlation to equity markets. Based in Brisbane, it is a regulated company, operating under an Australian Financial Services License (AFSL). In addition to facilitating the Opportunities Strategy USD 4 Year Bond, FHIM currently operate six strategies including a multi-strategy Fund and wholesale Managed Discretionary Accounts.
For this Fund, Ferguson Hyams sources strategies with verifiable trading histories from portfolio managers globally. FHIM performs the role of the administrator of this platform and selects strategies and managers according to its investment methodology. Ferguson Hyams derives its income from management and performance fees.
Bondholders (via Underlying Bond) effectively have protection by ranking senior to equity unitholders in the Fund. However, additional claims such as those of the Investment Manager, Advisor, Trustee, Banks, and Administrators will rank senior to bondholders. At the date of launch, the proforma debt to equity ratio of the Fund will be 100% and it is mandated that the Fund cannot exceed 200% of this ratio.
This effectively gives bondholders a loss-absorbing equity buffer. The claims of bondholders do rank senior to all fees earned by FHIM. This adds a degree of excess spread protection and aligns interests between bondholders and the investment manager.
The Underlying Bond will have an investment grade rating of BBB from Kroll Bond Rating Agency. If the rating is downgraded, the Underlying Bonds will be immediately redeemed at par plus accrued, which will pass through to bondholders.
Please see BA Report for further detail around the Legal Structure. We also have access to FAQ here.
|Product Type||Structured Note|
|Yield to Maturity||4.50%|
|Expected Maturity Date||6 September 2025|
A USD coupon/yield of 4.50% translates into an AUD ASW of 4% based on USD to AUD fixed-to-floating margin over swaps margin. The AUD 4-year swap is around 0.5%, so in AUD terms it’s also a comparable coupon/yield of 4.50%. This could be attractive for investors who are worried about AUDUSD depreciating even further below 70c. Not only do you get a relatively high coupon for a very low risk non-investment grade credit you potentially stand to benefit from capital appreciation through the AUD/USD.
Chart 6. USD Single-B/Single-BB Credit-Rating Yield Curve
Source: Bloomberg USD High Yield Index
USD single-B (Yellow) credit-rating yield curve
USD single-BB (Green) credit-rating yield curve
Chart 7. AUD Unrated/Rated High-Yield Equivalents