By Hamlin Lovell, NordicInvestor
Finland’s Aktia runs c EUR 10 billion in various traditional asset classes, including emerging market debt, European credit and European small cap equities, and most of this is managed internally. But its alternative investments, mostly alternative credit strategies, of c EUR 200 million – in comingled products and separately managed accounts – is all externally managed by 15-20 managers, which can be based in the US, Europe or emerging markets; none of the external managers are currently based in the Nordic region.
“Our trade finance portfolios have global approach and we have identified some managers with global approach, and some more regional ones, focus on Asian or African deals”, says Ville Toivakainen, Aktia’s Head of Alternative Investments, who has allocated to early stage managers and sometimes even been a seed investor on day one, when he would expect to be offered an ‘early bird’ fees discount. Portfolio turnover has been quite low as the universe of managers is rather small: he is only aware of about two dozen trade finance managers globally.
“The return target for trade finance, which is more broadly defined as supply chain finance, is around 6-8% net in USD terms and this does not really vary much by the location of managers, since the trade finance deals are usually USD-denominated even for managers in Europe. Aktia’s own emerging market debt business helps Toivakainen’s team to decide on country selection for trade finance deals. “We need comfort how the manager selects countries. The international trading hubs of Singapore, Hong Kong, Dubai and South Africa are key trading hubs, so are often high allocations”, he says.
The trade finance deals are collateralized, secured lending – using collateral such as commodities or consumer goods – which provides some degree of security, but the strategy is not without risk. Though aggregate statistics suggest that default rates are extremely low for trade finance, they do happen. “When managers have faced defaults and had to foreclose on, restructure or renegotiate loans, they have typically recovered most of the amount owed”, he confirms. The borrowers are mainly smaller and medium sized enterprises (SMEs) because larger companies can generally get funding from banks or public markets.
Aktia’s private credit portfolios have no overlap with its trade finance portfolios. “The mandate of the private credit is broad: In addition to traditional direct lending, we could allocate to strategies including special situations, distressed debt, asset-based lending, leasing, royalties such as music or film royalties or litigation finance. The time horizon for investments is five to eight years”, says Toivakainen.
One of the first allocations made by the private credit strategy has been aircraft leasing. The return target – an IRR of 10-12%, net of fees – is at the higher end of the range for asset-based lending strategies. “In aircraft leasing, the cashflow yield is in double digits, but this is partly a compensation for depreciation on the aircraft: their residual value when they are eventually sold or scrapped, will be lower than their purchase price. The depreciation is highest for new or younger planes, and less relevant for the 10-15 year planes that we are currently exposed to through a fund”, he says.
The crashes of Boeing’s 737 Max model could have been a serious problem for some aircraft leasing strategies exposed to this new plane. “But it is, if anything potentially positive for strategies that own older planes, as some airlines may need to replace 737s with older models”, he says.
Aktia is also looking at other asset-based lending strategies that target lower returns than aircraft leasing, and also fit in with the portfolios’ risk appetite. Toivakainen is not comfortable with the amount of leverage that some strategies, such as those involving regulatory capital, make use of.
“In distressed debt, we are looking mainly at the US, which is a much, larger and more well-developed market than is Europe, with a tried and tested bankruptcy process. China is the largest market for non-performing loans, but we are not actively seeking managers there due to concerns about the political and legal dimensions of the strategy”, he says.
Overall, he is open-minded about looking for new ideas in the credit space and is interested in litigation finance. The valuation policies of LSE-listed Burford Capital have become controversial after they were criticized in a report from short seller, Muddy Waters. Toivakainen would probably allocate to litigation finance via a closed end fund, where valuation polices are less of an issue because all investors enter and exit at the same time.
Aktia’s ESG policies seek and encourage good practices, but allow managers some degree of flexibility in how they implement ESG. For instance, Aktia certainly encourages managers to complete the UN PRI DDQ on private debt (which was developed by Archie Beeching, who now works at Muzinich, who Nordic Investor has interviewed) but does not insist that all managers are PRI signatories.
Private credit poses special challenges for ESG. “We recognize that private companies typically disclose less information than public companies, and so favour a company-by-company, case-by-case, analysis, rather than aggregated portfolio analytics which may work for equities or liquid credit”, says Toivakainen.
Focusing on the ‘G’ in ESG, Aktia has rejected some funds due to governance issues at the fund or management company level.
“We do not have any strict industry exclusions, but did decide against investing in one trade finance manager because it was doing tobacco deals. Alcohol could be acceptable if it was a small part of the deal-flow. Similarly, that fossil fuel related deals are 5-10% of the total costs. We have not seen any trade finance funds that are involved in weapons financing” he says.
Aktia could accommodate customized ESG criteria for separately managed accounts, though their current SMAs have not specified any ESG requirements.
“The next step for Aktia’s ESG approach will be to expand the universe to impact investing, including private equity, private credit and infrastructure, which could be done through a fund or separate mandates”, says Toivakanen. Investors should watch this space for the impact strategy roll out.