The alternative fixed income asset class – particularly when focused on SMEs – can offer investors attractive returns and diversification. As alternative lenders close the gaps in this segment, opportunities look set to flourish.
In a market with potentially 24.5 million borrowers – that is the number of companies of all sizes in Europe  – and attractive growth prospects (see exhibit 1), the public markets offer access to only one thousand of them, leaving a substantial opportunity for other platforms as channels for investors to invest in loans to small to medium-sized enterprises (SMEs).
We believe this asset class can offer investors attractive spreads and returns and, given the breadth of this market segment, considerable opportunities to diversify their fixed income portfolios.
The BNP Paribas Asset Management SME loans platform focuses on loans to small and medium-sized enterprises where the ‘illiquidity premium’ is 2% to 3%, resulting in potentially attractive returns for investors. That premium is linked to the complexity of the asset class: the effort to get access to this segment, the effort it takes to realise a loan and the degree of competition with other platforms. To be able to benefit from the opportunity, it is clear that substantial expertise is required.
Exhibit 1: SMEs – positive growth forecast for 2019
Source: BNPP AM, January 2019
Over-the-cycle assessment and sound credit analysis
On the BNPP AM platform, we grant companies loans with a maturity of up to eight years, covering an entire business cycle. It is therefore important to assess how the company’s business model operates through such a period before awarding a loan.
So, when selecting a company for a loan, we use set ‘knock-out’ criteria in the first phase. For example, the company must be profitable over time, the leverage should be capped and the cash flow should be sufficient. At the start of the credit process, we believe this creates clarity for the company as to the chances of a successful award.
In the second phase, we run a highly automated and industrialised credit analysis carried out by experienced professionals. This enables us to build and manage a healthy portfolio of SME loans for our investors.
ESG is a major focus
In providing loans to SMEs, we also pay close attention to the environmental, social and governance (ESG) aspects of the business, in line with our strong focus on sustainability. That means we systematically ask companies about their ESG policies: for example, what is their carbon footprint? By questioning a company on ESG topics, we underscore that we attach great importance to sustainability when it comes to the companies we lend to, the people who invest in our portfolios and for society as a whole.
We see attractive opportunities over the next five years. Insurance companies and pension funds are continuing to fill the gap in lending to SMEs which arose from regulations that sought to curb the ability of banks to provide long-term credit. For insurance companies and pension funds, however, it has become more attractive to be active in this segment. This creates opportunities for us in financing the needs of these companies.
We expect further technological progress to make the alternative fixed income market more transparent and accessible, which will also reduce costs and help the asset class move into the mainstream.
 Number of SMEs and large enterprises in the EU-28 non-financial business sector in 2017; SMEs growing beyond borders – European Commission – Europa EU
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.