September 10, 2020
Parts of the economy seem to have largely decoupled. Has the coin split? With the two sides of the coin being the real and financial economy? An obvious observation is that available capital is not finding the investment opportunities that are accessible at the moment. New alternative investment solutions can bridge this gap.
The real economy should provide solutions for consumers and businesses. The role of the financial sector is to provide financing and investment solutions to stimulate growth and innovation. In many developed countries, however, there is evidence of persistent weakness in growth and innovation. Innovation is increasingly driven by global giants, while the very important SME sector as a whole cannot develop enough innovative power.
Prof. Dr. Thorsten Hens from the University of Zurich explains: “The media focus on the five global stars, Facebook, Amazon, Apple, Netflix, and Alphabet, in short, the FAANG, tempts investors to neglect the equally innovative but locally operating medium-sized companies. This is a typical case of distorted attention, the well-known “attention bias” of behavioral finance“.
Things could be quite different here: The real and financial economy could create sustainable growth on a broad front through genuine innovation. Alternative investment solutions, for example, can bring benefits in various ways: In the form of venture capital, they support young companies in raising equity. In the form of private equity and private debt, they help established companies to grow. Such investment solutions are very interesting for investors and essential for companies to cover important financing needs. We are currently experiencing a unique investment environment characterised by low-interest rates and highly compressed risk premiums. The recent financial crises and government interventions to prevent recessions have led to an excess of liquidity in the financial system. The problem of using this money effectively in the economy has led to asset inflation rather than the hoped-for growth impetus.
For each investor, performance can be improved by expanding the investment universe to include alternative solutions. Each of these alternatives has specific benefits and risks. Whereby risks per se are not negative but must be understood and managed. Every risk is also an opportunity and a potential source of income.
These opportunities are already recognised by a couple of leading specialists: More and more professional investors are taking advantage of the investment opportunities in the so-called “private market”. Private debt is still a niche topic, but with a recent increase of 13.4%, it is one of the strongest growing asset classes. In Europe and Switzerland, the topic has gained momentum in recent years. The withdrawal of banks from certain sectors of the lending business is one of the driving forces behind the positive development of alternative investment and financing solutions. Banks are forced to exercise restraint as a result of increasing regulation, rising internal costs, and the new dominance of risk management and compliance. This withdrawal, in turn, offers exciting opportunities for investors. Today, private investors can also finance sustainable growth, close the gap that has arisen and benefit themselves.
Alternative investment solutions cover very different sub-markets. As in the equity market, the quality ranges from first-class to questionable offers. The specifics of each investment solution are decisive and must be examined in detail by professional private investors, mandated asset managers, or banks.
For Swiss investors, the asset-backed top segment is of particular interest, being characterised by attractive returns, determinable risks, and relatively high liquidity. The greatest challenge is posed by the limited availability of such investment opportunities, in contrast to other markets. The biggest risks are credit, interest rate, and liquidity risks.
Investment success lies in managing these risks and the ability to match investments and financing. The greatest challenges that solution providers are facing include the provision of capacity and the structuring of portfolios with targeted liquidity. One advantage of such financing solutions is the asset-backed nature that provides a certain level of security. In these cases, value, risk, and liquidity can be well assessed. Besides, asset collateralisation provides a tangible security. Financing of receivables is a good example of this if the receivables are actually purchased as part of a transfer of ownership and do not just serve as loose collateral for a loan. In this case, outstanding receivables are purchased in a legally sound manner before they become due and are pre-financed for a certain fee. The selling company thus receives immediately usable liquidity.
It is particularly attractive for fast-growing and innovative companies to release the liquidity otherwise tied up in their supply chains. High diversification, short maturities, and excellent payment histories characterise receivables portfolios that are particularly interesting for investors. Thanks to these characteristics, investment solutions secured by real value achieve a high degree of stability comparable to other investment-grade investment solutions. An attractive risk profile with minimal default risk, steady income, and attractive liquidity make these solutions interesting for conservative investors, such as pension funds. When selecting appropriate investment products, the focus should be on the details of the specific investment solution in addition to the individual investment objectives and risk tolerance. Only a few providers successfully master the physical, analytical, and legal implementation.
All sides benefit from successful new alternative investments, such as solutions for working capital finance: Investors receive higher and uncorrelated returns. Medium-sized companies receive the capital they need, and the economy grows faster through innovation. In this way, the two sides of the coin can once again be reforged.
Joscha Rosenbauer, Managing Partner und CEO, Pactum AG.