Capital MarketsInvestment Management

Kicking the Tires: Investing Cash in Working Capital Finance

By November 17, 2022No Comments

Supply chain finance offers attractive yields uncorrelated to other assets, but non-IG funds present an obstacle.

The search for attractive yields uncorrelated with—and more resilient than—other fixed-income investments led the investment arm of a large, privately-held multinational corporation to a fund that invests globally across trade receivable, payable and inventory finance assets.

  • Representatives from Koch Investments Group and Pemberton Asset Management, a specialist alternative credit manager, discussed the benefits of the working capital finance asset class at a recent NeuGroup session organized for members of NeuGroup for Cash Investment.
  • A number of members who work at public companies said that while the potential returns and diversifying nature of investing in a working capital finance strategy are intriguing, investing in a non-investment grade fund could prove difficult under their current policies.

Working capital assets. “The investment is, traditionally speaking, a fund,” said Pemberton managing director Scott Hamilton in explaining the concept. “A corporate will get their pro rata allocation across all the assets in the fund, so you would be diversified across the entire portfolio of the working capital assets that we have originated.”

  • According to Pemberton’s presentation, those assets include receivables and payables with tenors ranging between 30 and 360 days from companies with average credit ratings of BB-. Additionally, Pemberton offers an insured (single-A credit insurance) share class and note forms.
  • Pemberton sources the assets through its own origination, as well as from banks and supply chain finance platforms. The return for investors comes in part from the difference between the discount and what the buyer ultimately pays Pemberton, net of fees.
  • Mark Hickey, Pemberton partner and co-founder, said that targeted gross returns of Libor plus 250-300 basis points can be achieved while maintaining zero duration risk, low volatility and very low loss rates.
  • Amid extensive global market volatility in the last year, Mr. Hickey noted the relatively low volatility and favorable performance of Pemberton’s strategy relative to comparable credit indices (see chart below).

Alpha additive. Ben Tuchalski, a director at Koch Investments Group, said Koch was encouraged by Pemberton’s credit and underwriting capability, which helped overcome some initial hesitancy about the asset class. The firm approved the investment in early 2021.

  • “We’re starting to focus more on our beta exposure in liquid credit, and this is one that’s alpha generative and alpha additive,” he said. “It’s done what it’s supposed to do, it’s diversified away from our other mandates within this section of the portfolio, and it’s provided us an uncorrelated return stream.”
  • He added, “We’re happy with it, and the proof’s that we’ve provided more capital. It was a no brainer for us.”

Investing obstacles. Member feedback at the session suggested wide acceptance of working capital finance as an asset class has not arrived. Treasury professionals charged with investing corporate cash may have liquidity and safety concerns due to the credit ratings of buyers that participate in Pemberton’s supply chain finance program. Plus, the fund itself is unrated.

  • Mr. Hickey said the fund is “not set up to be a structured finance product with an investment-grade rating, because there are a number of features in structured finance ratings that you need to build in that our fund wasn’t designed to do.
    • “That doesn’t mean we couldn’t do that at some point, but we’d have to set up a separate vehicle to be investment grade.”
  • Accounting could present another obstacle. “It will be part of the leap for a corporate treasurer because the underlying investments are not publicly traded CUSIP assets, Mr. Hamilton said.
    • “They are private in that regard, but liquid and tracked internally on a daily, marked-to-market basis by us, allowing for any payment breaks to be caught in real time.”
  • However, some treasury teams at cash-rich, tech firms allocating more resources to strategic investment are considering adjusting their investment policy to allow for this investment, according to Mr. Hamilton.

Informed perspective. NeuGroup’s Scott Flieger, who facilitated the session, said the development of a capital market for working capital finance programs could ultimately present an opportunity for more corporates, but the asset class may need some time to mature.

  • “It is logical to assume that corporations with large cash balances with a small percentage dedicated to alpha returns would be expected to be the first mover into WCF assets, but with several important caveats,” Mr. Flieger said. “Credit reviews will be intense and understanding precisely how liquid these assets are, especially in volatile markets, will be of paramount importance. Investment policies may need to be modified, as well, to permit investments in non-rated assets.”
  • He added, “A capital market developed for WCF assets may be beneficial for corporations that currently have large supply chain finance programs which rely on their banks for short-term credit. WCF programs provide many benefits around managing working capital and have been described as the gift that keeps on giving. If banks reduce their credit commitments to WCF programs because of regulatory or market forces, having a capital market for WCF assets could prove quite important.”
Justin Jones

Author Justin Jones

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