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US Consumer Credit: Stable Returns in an Unstable Investment Universe

(The original article was published in the Asian Private Banker website)

The start of 2019 has been troublesome with an ominous combination of factors threatening further market turbulence.The longest US government shutdown in history record has damaged livelihoods and dented market confidence; the arduous process of Brexit is approaching a chaotic endgame and spreading uncertainty across Europe; weakness in industrial output has shaken the continent’s powerhouse Germany; and exports have fallen in China as it remains mired in a protracted trade war with the US.

All of this comes after a 2018 that was tough enough for investors. According to FinEX research, approximately 85% of asset classes were in negative territory over the course of the year. The stock market took the biggest hit with the S&P 500 and the DAX down 4.39% and 18.26%, respectively. Hong Kong’s stock market fell 10.55% while China’s tumbled 22.74%. The performance of the bond market was also weak while corporate bond indices across the globe saw losses. The only exception in the market seemed to be for safe-haven assets which themselves only offered modest yields of around just 2%.

Local Currency Yield Return (%) in 2018


Source: FinEX Asia Investment Limited

So what has the impact of these troubled times been on wealth? Based on the Capgemini’sAsia-Pacific Wealth Report 2017 and the World Wealth Report 2018, APAC ex-Japan HNWIs allocated 17% of their investments tofixed income and 10% toequities as of June 2018, meaning more than a quarter of their investments would have been affected by the downward spiral of stocks and bonds. In short, it was not a good year for individual wealth.

Cash is not always king

In a climate of market volatility and headwinds, holding cash may seem attractive. Accordingly, HNWIsin APAC ex-Japan allocated 26% of their investments tocash or cash equivalents, as of June 2018. However, the implied inflation accompanying a rising interest rate environment reduces the relative value of cash.

During these periods of market turbulence, a lack of yield becomes the new normal that each investor seems destined to live with, which begs the question: Are there other investment options?

Lessons from the 2008 financial crisis

It is the multi-million dollar question: Can investors swim against the prevailing currents and achieve stable and predictable returns, low volatility, and low-to-no correlation to other markets? The graph below showing which how major banks navigated the 2008 financial crisis provides valuable insights into the investment that helped them survive and flourish.

Credit Card Performance (%) 1995 to 2016


Source: Federal Reserve Board

US consumer credit has been a major asset class on banks’ balance sheets and has proved to be consistently good value. Even during the US economy’s darkest periods, consumer credit has provided positive returns for US banks.

The benefit of consumer credit versus traditional fixed income instruments is subtle but important. US consumer credit has a low correlation with other asset classes and a positive correlation with the Fed Funds Rate (see chart below).

This correlation appears counterintuitive considering how bond markets react cautiously to rising rates. However, one reason for the correlation is that commercial loans and bonds tend to be fixed-rate instruments, repaid in a single bullet payment at maturity. This means they reprice to match prevailing issues.

However, consumer credit amortizes on a monthly basis, meaning monthly payments predominantly comprise principal payments on top of some interest. The principal payment can then be reinvested in new consumer loans that originate at the higher interest rate.

US Credit Card Interest Rate, Fed Fund Rate and Treasury (%) 


Source: Bloomberg

Consumers tend to be less sensitive to rising rates in terms of their willingness to borrow, and strong market fundamentals also generally mean strong employment and lower defaults. We have evidence regarding this theory close to home.

The Orchard US Consumer Marketplace Lending Index (see chart below) has a proven record of stable, rising net value over the past decade, reflecting the uniqueness of the consumer credit asset class which demonstrates an upward historical performance with low volatility.

Orchard US Consumer Marketplace Lending Index


Source: Bloomberg

Only half a dozen asset classes could hold a candle to the returns, and a top decile and stable performance are impressive when 85% of asset classes are in the red.

In an unstable world, investment managers who are capable of bringing stable returns stand out from the crowd. However, investors are normally advised to allocate their assets to cash or other safe harbours to avoid volatility while simultaneously surrendering investment returns. This implies that stable returns and volatility is a trade- off.

Investors can never have it both ways. Over the past two years, more and more investors have sought out alternative investments, and broadening the landscape of different asset classes may be the best solution to the current dilemma investors face.

US consumer credit has proved itself dependable through the during the economy’s hardest times, generating consistently positive returns in a challenging investment environment. It is an asset worth knowing and investors stand to benefit if they acquaint themselves with this most dependable of investments held by all the major banks through times good and bad.

Read the original article in the Asian Private Banker website

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