SME-LOANS AS BOND ALTERNATIVE AND INFLATION HEDGE?
We have covered inflation worries and the related interest rate outlook early on in one of the last blogs – and our views were pretty much spot on! The traditional credit market is no option for investors that do not follow the appeasing central bank rhetoric, the stock market could be difficult in the transition phase from the old financial regime to the new one. So, investors look for good niche plays in order to muddle through – like floating rate notes and inflation linked bonds in the credit space and non-directional exposure to the stock market in the equity space.
SME (small and medium-sized enterprise)-loans have always been a sub-asset class with an interesting yield pick-up. With a good manager you could realize low default rates and get an attractive risk-return profile. If structured as a bond, of course, you would undergo yield curve and market risk in addition to the credit risk. With a collective investment vehicle for non-listed loans this could be avoided, but usually you had to take a substantial minimum investment and were stuck with the investment for a long time.
More recently SME-loans can be digitalized, allowing for more flexible direct investments as well as for funds with shorter investment periods. This way SME-loans as a sub-asset class in the credit space become a more interesting investment alternative. Studies have shown that the yield pick-up to corporate bonds is tiny (3.66 -vs- 3.28 for the last 10 years according to ECB data) but there is a substantial advantage in volatility (1.69 -vs- 3.81) resulting in an attractive risk-return pattern (Sharpe Ratio of 2.16 -vs- 0.86). Besides, the correlation of SME lending with other asset classes is very low (between 0,04 and 0,4 rounded up), allowing for improved portfolio robustness. Low correlation means that this asset class does not move very much aligned with others.
Does that help with higher inflation? Yes, at least if yield curve risk is not reflected in the reported price of your investment. The rest is in the nitty gritty details of loan contracts: if the interest rate payments are linked to a price indicator, you should be fine. If not, you lose purchasing power just like with other credit investments that are not flexible or linked. But to get price risk out of your performance reporting and increase the robustness of your Portfolio can be a nice adjustment of your wealth to a more sophisticated and balanced state.