As Traditional Markets Dim, Consumer Credit Shines

The pursuit of attractive investment opportunities has become increasingly tumultuous as political and governmental uncertainties escalate. Following the 2008/9 financial crisis, investors expected central banks to gradually curtail Quantitative Easing (QE), a monetary tool whereby a central bank purchases government bonds to inject liquidity into the economy, and subsequently raise interest rates after the global economy begins to recover.

Contrasting to popular belief, central banks around the globe have embraced QE as a mainstay of economic policy. Central banks from Japan, the US and the UK have shown few indications of ending QE; furthermore, the European Central Bank, desperate to boost inflation, has stated its own plans to restart QE.

As central banks attempt to kickstart domestic economic growth amid weak inflation, they are expected to continue QE measures and cut benchmark rates. QE is severe enough that rates in many countries have turned negative, putting continuous downward pressure on interest and bond rates.

Growing Risk Perception

Pessimism on growth has led to a broad stock market sell-off. The trade war, geopolitical risks and a general economic slowdown have discouraged capital flows into equity markets. As a result, attractive equity market return has become elusive. According to Morningstar data on US mutual funds and ETFs, cautious investors pulled US$60 billion out of equity funds in the third quarter and instead flocked to bond funds. Investors also kept record amounts in cash to safeguard amid US-China trade tensions, Brexit troubles and mounting global economic concerns.

However, about US$17 trillion worth of bonds currently carry a negative yield. The average bond yield, including high-yield and riskier emerging market debt, is a mere 1.5%. Declining yields have deprived bondholders of the income opportunities that drive sustainable returns.

Lofty valuations and slowing growth have weighed on investor risk perceptions towards equity markets and, coupled with meagre returns from bond and traditional fixed income products, have left few attractive investment options.

The Rise of Alternative Investments

Diversification is crucial to achieving a well-balanced optimized portfolio that can weather any economic storm. However, with the current lack of market opportunities, many investors do not know where to turn.

An increasing number of institutional investors are warming to consumer loan as alternative investment class for attractive returns. Consumer loan is alluring due to its strong diversification appeal, low correlation to traditional asset classes and equity-like returns with bond-level volatilities. In the current climate of rising equity volatilities and lower bond yields, demand for alternative assets has soared.

Particularly amongst the current macroeconomic uncertainty, investors appreciate the defensive nature of consumer loan’s investment yields. Compared to bonds, consumer loan typically has a shorter maturation period, thus reducing its sensitivity to interest rate changes and lowering its exposure to underlying credit risk over time. The underlying loans are priced at variable rates and amortize monthly, differentiating them from commercial loans and bonds that typically have fixed rates and are repaid upon maturity in a single lump sum payment.

The Key Driver: US Consumer Credit’s Proven Track Record

Investing in consumer lending has exhibited attractive absolute and risk-adjusted returns – even during periods of market uncertainty. Its performance has shown resilience during times of financial distress like the 1997-98 Asian Financial Crisis and the 2008 Global Financial Crisis as well as more recently during the initial Brexit concerns in 2015 and the US presidential election of 2016 when other traditional asset classes struggled.

With its well-developed capital markets and highly regulated consumer credit markets, the US will remain the epicentre of the consumer loan market. Despite a slowing global economy, the US consumer remains in relatively good shape. US unemployment continues to remain near multi-decade lows, household spending is edging higher, and mortgage delinquency rates are at 20-year lows. The Federal Reserve’s policies have also helped support spending and home buying.

As the global marketplace braces for a potential downturn, investment portfolios must be strengthened to effectively manage risk and withstand potential headwinds. It is crucial to diversify portfolios with various asset classes that will react differently to market events – thus minimizing risk and maximizing returns.