Stockholm (HedgeNordic) – With high-yielding opportunities in public fixed-income markets being few and far between, investors have been exploring lesser-known or out-of-the-public-eye corners of finance. Swedish asset manager Skandinaviska Kreditfonden AB (Kreditfonden) has set out on a journey to develop a product range that focuses on some of these corners of fixed-income markets with the aim of becoming a leading player in direct lending to Nordic companies.
Kreditfonden currently manages three – soon-to-be four – alternative investment funds focused on providing capital to Nordic small and mid-size enterprises (SMEs) through different strategies. “First and foremost, we have Scandinavian Credit Fund I that has been up and running since January 2016. The fund provides loans to Nordic SMEs with ticket sizes in the range of SEK 30 to 300 million with tenures of up to 48 months,” explains Fredrik Sjöstrand (pictured), the founder of Kreditfonden and CIO of SCF I.
“First and foremost, we have Scandinavian Credit Fund I. The fund provides loans to Nordic SMEs with ticket sizes in the range of SEK 30 to 300 million with tenures of up to 48 months.”
The second product is the Nordic Factoring Fund, which buys factoring loans via a third party from companies looking to strengthen their short-term liquidity by selling their account receivables. “In the beginning, we had receivables in Scandinavian Credit Fund I as well. But we liked the characteristics of that asset class so much that we decided to offer investors separate exposure to its attractive risk-return profile,” says Sjöstrand. “Of course, liquidity in that fund is not great,” he acknowledges.
Investors in the Nordic Factoring Fund have to give a 90 days notice to redeem capital, with redemptions limited to quarter-ends. “You cannot get exposure to something that returns six percent or more per year, with a high Sharpe ratio and a pool of 30,000-40,000 receivables that turn around every 90 days without a price. And the price is illiquidity,” explains Sjöstrand. “This fund has a very special risk-return profile.”
“In the beginning, we had receivables in Scandinavian Credit Fund I as well. But we liked the characteristics of that asset class so much that we decided to offer investors separate exposure to its attractive risk-return profile.”
The last up-and-running fund is the High Yield Opportunity Fund, a closed-ended alternative investment fund that invests in lower-rated loans in the Nordic bond markets. “This fund buys listed high-yield bonds, and benefits from a twist in its construction that limits one’s exposure to other investors’ behavior,” particularly indiscriminate selling due to short-term fear. “If an investor has an investment horizon of 3-5 years and the market goes upside down, we will not be forced to sell the assets we want to keep because of big redemptions,” says Sjöstrand.
With its original launch put off by pandemic-induced challenges, Kreditfonden is set to launch its fourth fund – the Nordic Direct Lending Fund – as an evolution of Scandinavian Credit Fund I. Like its predecessor, the Nordic Direct Lending Fund is “a private debt fund focusing on direct lending activities with loans in the range of SEK 150-500 million with much longer tenures,” according to Sjöstrand. This fund buys private loans with an average tenure of about 60 months and purely caters to institutional investors that can accept a closed-end structure with an eight-year lock-up period in exchange for an annualized return of 5-7 percent net of fees.
“This launch will help us on our journey to become the leading provider of direct lending strategies in the Nordic region.”
“With our two direct lending strategies, we now cover loans with tenures ranging from three-four months up to eight-nine years,” says Sjöstrand. The soon-to-be-launched fund “is a natural progression following on our success with the first fund,” he emphasizes. “This launch will help us on our journey to become the leading provider of direct lending strategies in the Nordic region.”
Inflation and Credit Risk
Inflationary pressures have increased significantly this year, driven by recovering economies, supply chain bottlenecks and higher energy prices, among other things. The true nature of the recent inflation bout has become clearer over time. “I don’t think inflation is transitory at all,” claims Fredrik Sjöstrand. “Markets should have seen increasing interest rates much earlier than the current forecast in the market right now,” he continues. “If central banks did that, they would not have to raise rates as much as they will have to otherwise. Central banks are usually behind the curve.”
With inflation on the forefront of investors’ minds for much of the year, the main questions focus on how inflation risk and the prospect of higher rates will impact all types of assets and investment products. While publicly-listed fixed-income instruments usually fall in price in a rising rate environment due to their inverse relationship to interest rates, private debt does not lose value in the same way. Credit risk plays a much larger role in determining the value of private debt than in many traditional bonds, so private debt instruments are subject to different accounting treatments.
“Due to the fact that our underlying investments are subject to IFRS 9, their value does not depend on the level of interest rates so much.”
“Due to the fact that our underlying investments are subject to IFRS 9, their value does not depend on the level of interest rates so much,” explains Sjöstrand. “We were not able to increase the value of our assets when interest rates fell during the last couple of years, like all the marked-to-market instruments,” he elaborates. “If we see a general increase in interest rates, we will not be forced to decrease the value of our underlying investments. An increase in the level of interest rates means that we can reinvest that money at higher rates when our loans mature.”
Kreditfonden’s direct lending and factoring funds have both been affected by the low-rate environment of the past decade. “If you go back in time two or three years, we could lend capital at rates that reached an average of 9-11 percent,” says Sjöstrand. “In this low-rate environment, we are lending in the range of 7-9 percent.” The low rates have acted as a headwind for Kreditfonden’s strategies so far and can, in turn, act as a tailwind in a rising rate environment.
“Our job is to produce a steady return, regardless of the direction of interest rates,” emphasizes Sjöstrand. “The thing that we are exposed to is credit risk,” he asserts. When investors end up evaluating Kreditfonden and its funds, they should assess the team’s capacity to perform a proper and thorough credit risk analysis of the underlying issuers of either direct loans, account receivables or high-yield loans. “For that, we have a team of four people on origination and analysis, the rest of the investment team, the credit committee, our external auditors and internal auditors, and then compliance and independent valuation within Finserve Nordic AB,” says Sjöstrand. “There are many, many heads and eyes assessing the credit risk of our potential investments before they get into our funds.”
Sustainability and Impact
The asset management industry has seen the embrace of sustainable investing move from exception to expectation and norm. Formalized integration of environmental, social and governance (ESG) considerations has become the norm, with Kreditfonden also formalizing its approach to responsible investing. “We have now formalized our sustainability efforts through an ESG policy and by joining the UN PRI initiative, which was not such a big step for us because we had a soft ESG policy in place since inception,” says Sjöstrand. “For us, it has not been a difficult process to convert our efforts into a formalized sustainability policy.”
“We have now formalized our sustainability efforts through an ESG policy and by joining the UN PRI initiative, which was not such a big step for us because we had a soft ESG policy in place since inception.”
Kreditfonden’s Scandinavian Credit Fund I and Nordic Direct Lending Fund are both classified as “light green” (Article 8) funds under the European Commission’s Sustainable Finance Disclosure Regulation, which puts funds into one of three categories. A so-called Article 6 fund has no clear environmental, social or governance objectives. An Article 8 fund, commonly referred to as “light green,” is broadly defined as one that furthers an environmental or social aim in some way. An Article 9 fund, or “dark green,” must have sustainability as its sole objective.
“We do not have the ambition to join the “dark green” group,” says Sjöstrand, arguing that “we could not meet the return targets we have by being “dark green” funds.” Sjöstrand and his team “want to have the capacity to have a broader investment space than the one that falls under the definition of a “dark green” fund.”
Kreditfonden has also been granted a guarantee from the European Investment Fund (EIF), with 70 percent of the credit risk being transferred to the EIF on new loans where the guarantee is applied. The guarantee, deployed through both Scandinavian Credit Fund I and Nordic Direct Lending Fund, makes available up to SEK 3.0 billion in advantageous lending for Swedish, Danish and Finnish companies impacted by the coronavirus pandemic. With the EIF having strict demands on sustainability, Sjöstrand says that “we are proud to have been included in the credit program by the EIF. Being included means that our rigorous analyzing processes as well as our lending and sustainability policies have been extensively tested and approved by the EIF.”
This article features in HedgeNordic’s 2021 “Alternative Fixed Income” publication.