Hedges left to grow


James Klatsky was one of many individuals mentioned in the first issue of GTR back in 2002. Here, he looks at alternative sources of trade finance, namely hedge funds, and how these have evolved in the past five years.
Emerging market finance is a continually evolving asset class which has seen cyclical movements regarding participants and products. The trade finance component reflects the overall asset class although it can be argued that it has remained significantly more stable in terms of products, monetary volumes, pricing and the overall credit quality of the transactions.


We have also witnessed a number of types of investors that have participated in the trade finance industry. This includes commercial banks, industrial and trading companies and specialty finance companies.


These facts are certainly well known to those of us who have participated in the industry over the years. It is particularly apparent to our colleagues who have seen a number of these cycles and witnessed the evolution of the asset class.


Branching out
With this in mind, several years ago, coincidental with the launch of GTR back in September 2002, we witnessed in the hedge fund world, a growing interest in more varied and eclectic strategy diversification.


There are standard strategies which are well known to investors, however; a growing group of investors are interested in what is referred to as ‘alternative alternatives’, meaning that they are interested to consider investments in strategies which are outside of the better known and more widely offered approaches for participating in hedge funds. They consider these strategies in order to provide their investors with more diversity and ability to create uncorrelated and stable returns.


Trade finance was deemed to be a unique strategy which meets many of these objectives. The challenge was to educate potential investors to the asset class. Most investors do not have a background or significant knowledge in the many aspects and risks in trade finance.


Over the past five years, the knowledge base of the trade finance asset class has grown amongst hedge fund investors. We must give credit to the pioneers in this trade finance/hedge fund field who have spent significant time and effort in the education process.


The investors have given greater recognition to the non-correlated nature of the returns and risks. This is in part a consequence of following the asset class over a period of several years as well as a focused approach on the part of some investors to more completely understand the asset and the business of trade finance.
Who to trust


From the point of view of the trade finance world there has also been a growing acceptance of the new participants in the industry. In particular, questions often asked are, who are these funds, are they reliable and what their counterparty risk is.



These considerations are approached from different perspectives. In other words, can they be relied upon to perform on commitments

  • Many of the individuals in the new hedge funds are people known in the industry from past experiences and this allows acceptance based on knowledge of the individual rather than the history with the new business entity, the hedge fund.



Acceptance is created once a track record is established and as transactions are successfully concluded, credibility is established. The questions of what are hedge funds and should we do business with them has largely disappeared and the focus now is on the specific institution.


On the other hand it is very important to keep in mind that the trade finance professionals, if they want to access funds from institutional hedge fund investors, must be educated as to an understanding of how hedge funds are managed and similarly what are the forces and objectives that would make an investment in a trade finance focused strategy or business attractive.


In general, the thinking process of a manager must be adjusted as compared to the method of contemplating a business product line at a bank or other financial institution. The focus is on multiple investors that put an emphasis on the liquidity of their investment and return on their focused investment.


Compared to banks
This is compared to a broader strategic business view that a bank might consider on a product line analysis.


The hedge fund investor analysis process puts a strong emphasis on the individual manager, the team and very importantly the track record which can be clearly exhibited by the manager.


The best way to do this is by providing an experience profile over several years. The overriding issue for the manager is to be fully cognizant that their ‘master” is the investors and not ‘senior management’s of a financial institution.


Managing in this manner might be simpler to the extent that the issues have a greater focus. However, the hedge fund investors are more demanding as to their objective for returns and have a shorter time horizon to tolerate missed targets, hence their requirement for liquidity in the fund.


What we have learned over the past several years as it relates to the introduction of trade finance into the hedge fund world is that it is an intriguing concept from both the perspective of the hedge fund investors and trade finance professionals.


However, the assimilation of the cultures and the acquisition of a knowledge base is an evolutionary process and clearly the onus is on the trade finance professional to find a way to meet these requirements which will both provide an attractive opportunity for the investor and a source of new capital for the trade finance world.