SME Lending; an asset class for the long run?
Our previous article discussed how SME lending fared compared to Stocks and Bonds and via Robo-Advisories. We concluded that with SME lending, investors could invest in a broader range of companies with low correlation as the level of diversification helps to mitigate the volatility caused by Covid-19.
As this alternative asset class steadily gains traction and shows promise to grow, we look at how it can fit in an investor’s long-term investment strategy.
If there is a valuable lesson we have gained from the pandemic and can all collectively agree on, diversification remains crucial to any investor’s portfolio. The phrase, “never put all of your eggs in one basket,” resonates now, more accurately than ever. Unlike other traditional asset classes, diversification, being one of the primary tenets of SME lending, allows you to spread your investments across sectors, tenures, and facilities.
For a start, your dedicated Relationship Manager (RM) would demonstrate how you can operate the platform to allocate an investment amount you would be comfortable in each of your preferred facilities based on product type, interest rate, tenor, and borrower. You may choose to gradually increase your allocations as you gain comfort with the platform and the types of loans available to invest in.
Investing through the Validus platform is usually a straightforward process; investors can expect a 20% administration fee, payable on all returns earned through the platform, meaning Validus only claims a fee when there is a repayment to the investor and an interest-earning from the investment. The fees are reflected in the Account Summary page on a cash basis and can be viewed in detail via the Transactions tab.
As there is no management fee and investing thus comes at no cost to the investor, this becomes an attractive feature where most brokers and fund managers will charge a fee for every buy/sell. Cost-sensitive investors would find that Validus’ model is success-based and involves no upfront cost.
3) Less Volatility and Low Correlation
With its low correlation to the public markets, SME lending tends to remain stable in performance regardless of the macroeconomic situation, one of the most significant features of this particular asset class. Each facility has its repayment risks mitigated with ring-fencing mechanisms.
Investors on the Validus platform can check their investments on the go via the app downloadable via the App Store or Google Play to remain constantly on top of the status of their investments. The risk of default on payment obligations will always be involved, but high liquidity and smaller investment sizes diversified across a range of loan products and borrowers allow investors to tweak their strategy continuously.
4) Liquidity advantages
The SME lending asset class offers short-term liquidity as compared to other asset classes available. When comparing stocks vs. SME lending, investors only experience a stock loss when they choose to sell if their portfolio is down, for example, by 50%. It can land an investor in a rather undesirable situation, trying to cut their losses when the stock market is down.
A similar situation with FinTech based SME lending is improbable, where if well-diversified across many loans, single defaults will create less magnitude of impact on returns.
For SME lending, when an investor experiences a loss, it is called a default. While defaults are unpredictable, every platform employs different risk mitigation strategies; Validus takes a holistic 360-degree approach from its partnership-led strategy to a ring-fenced payment mechanism. It was also the first platform in the ASEAN region to offer a unique insurance cover, which it has obtained from the global insurer, Coface. This leading trade insurer provides insurance on select trade financing facilities on the Validus platform, essentially protecting 100% of investors’ principal amount invested.
Compared to other investment instruments available to accredited investors, SME lending offers higher returns at market-plus rates while also supporting SME growth and the economy.
Accredited investors on the Validus platform can expect an 8-12% P.A. net IRR return.
SME lending is a strong addition to any investor’s long-term investment strategy and portfolio mix. Beyond the conventional financial interest, an investor may consider, given that SMEs are the backbone of the local economy, investing in their future makes good economic sense and facilitates a positive impact.
Our country is poised for recovery in this challenging landscape. As a result, the demand for financing for SMEs resuming business and procuring supplies and labour has been steadily increasing.
SME lending as an asset class offers investors the opportunity to take advantage of a diversified range of opportunities to support the same, concurrently facilitating low-volatility investing at a higher yield, ongoing liquidity, and greater portfolio diversification.
However, as with any investment, the investor is always encouraged to do their research, understand the product and how it may add value to a portfolio and the risks involved.