The Advantages of Fintech Lending in a Rising Interest Rate Environment

We expect that Fintech-enabled lending strategies will continue to generate attractive risk-adjusted returns despite the regime shift to a higher interest rate environment. An allocation to Fintech lending can provide diversification and strong downside protection in contrast to the anticipated headwinds that private equity and private credit senior debt will likely contend with in the higher interest rate environment.

U.S. private equity has generated outsized outperformance since the Global Financial Crisis (GFC), due in large part to a historically low interest rate environment. Private equity outperformance accelerated in the last five years as a result of 1) the move back to a zero-interest rate policy framework, 2) the restart of quantitative easing and 3) unprecedented fiscal stimulus in response to COVID dislocations.

The challenges for private equity investing primarily relate to sharply rising debt costs and falling valuations, as the historic overvaluation in public equities has started the process of unwinding.

We believe that the higher interest rate environment may prove to be more persistent than market participants currently anticipate due to a unique set of factors:

• Stubbornly high inflation with limited impact to-date from Fed policy rate hikes
• The risk of inflation expectations being anchored at the current elevated level of inflation
• The fastest pace of central bank interest rate hikes in the last 40 years
• The risk of additional interest rate hikes if inflation remains high
• Slowing economic growth may lead to stagflation
• Higher fixed income volatility
• Record global debt levels (global debt is now equal to 335% of GDP) that continue to rise
• US regional banking stress, accelerating the disintermediation of traditional bank financing and the tightening of financial conditions

In 2023 to-date, equity markets have decoupled from fixed income and commodity markets as equity markets have rallied and equity volatility has declined while commodities and long-term interest rates have moved well below their 2022 highs. Equity markets appear to be positioned for one of the following low probability scenarios:

• The Federal Reserve to effectively lose its nerve and cut its policy interest rate when the much-anticipated recession finally hits, despite the fact that inflation is well above the Fed’s 2% inflation target.
• A soft-landing scenario is expected, which disregards the historical experience of the negative economic and market impacts of sharp interest rate tightening cycles and a historically rare plunge in the money supply.

The current environment is driving a continued increase in institutional demand for private credit strategies to help add much-needed portfolio diversification. Over the past decade, the private credit asset class has grown by more than 20% per year, with current private credit assets equal to $1.5 trillion. Private credit is expected to see significant growth as institutional portfolio allocations are projected to increase from 3.8% to 5.9%.

Private credit covers a wide array of underlying strategies with a diverse set of return drivers as compared to other alternative asset classes. The universe of private credit can be segmented into four sectors: (1) Corporate Credit; (2) Specialty Finance; (3) Structured Credit; (4) Real Assets Credit. Specialty finance strategies are income-oriented and comprise asset-backed trade finance, receivables, consumer lending, asset-based lending, royalties, etc.

Fasanara’s Fintech-enabled receivables and consumer lending strategies are a niche, new asset class experiencing high growth. These lending strategies require highly specialized expertise and technology and, as a result, have high barriers to entry, which can help investors achieve their investment objectives across different macro regimes. Unlike the typical highly-leveraged private credit senior debt or mezzanine fund, which in a recessionary environment may need to divert cash to servicing debt refinanced at higher interest rates and thus experience lower returns, Fintech lending strategies are not exposed to a potential large spike in defaults or lower returns if a recession occurs.

Non-bank Fintech lending strategies, like Fasanara’s, have successfully navigated through the zero-interest rate, low inflation, COVID environment and the current higher interest rate, inflationary market of today. These short-duration strategies have a proven track record of dynamic rebalancing, allowing for proactive sector diversification in response to changes in the macro environment. The keys to success are having a technology-enabled systematic investment process, extreme diversification, leading-edge credit risk management and structural downside protection.

Financial technology has increased the efficiency of financial transactions for both businesses and consumers, allowing non-bank lenders to provide capital to creditworthy borrowers who cannot access traditional financing. Fasanara leverages its position as a market leader in the Fintech lending space in this higher interest rate environment by repricing existing transactions at an additional premium to enhance the risk-adjusted returns of its strategies.

We believe that Fintech lending strategies, like Fasanara’s, can help investors achieve their investment objectives in the current high interest rate environment, in contrast to finite-life private credit funds, by demonstrating the following capabilities:

1. Stable Income Generation – Diversified source of income can provide inflation protection
2. Attractive Risk-adjusted Returns – Low risk, diversified portfolio can generate attractive risk adjusted returns across market cycles
3. Downside Protection – Systematic portfolio structure and credit enhancements can provide structural downside portfolio protection
4. Lower Correlation – Extreme portfolio diversification results in low or negative correlation with public market returns
5. Low Volatility – Low duration and leading-edge machine learning credit risk management results in less exposure to downside volatility
6. Barrier To Entry – Sourcing network with best-in-class portfolio of global Fintech originator platforms enables fast underwriting, enhanced risk monitoring and increased capacity. These platforms lend to under-banked markets and can charge higher interest rates to offset some of the increased credit risk and operate with lower overhead due to Fintech efficiencies
7. Alignment of Interests – Open-ended strategy with liquidity terms more closely aligned with the underlying investment strategy

A successful Fintech lending strategy needs to have the vision and expertise to create a multi-platform Fintech global originator network supported by the build out of a deep internal IT team, similar to what Fasanara has accomplished since its inception. Fasanara has a deep commitment to responsible investing, and our Fintech lending strategies have a positive, direct impact on the real economy. We also strive to incorporate gender equality and ESG principles to disseminate best practices across our ecosystem of investors, platform originators and SME’s.

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Disclaimer

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Important information on risk

Investing involves risk. The value of any investment and the income from such can go down as well as up, and you may not get back the full amount invested. Past performance is not a guarantee of future returns. Changes in the rate of exchange may also cause the value of overseas investments to go up or down. This information represents the views of Fasanara Capital Ltd and its investment specialists. It is not intended to be a forecast of future events and/or guarantee of any future result. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. There is no assurance that an investment will provide positive performance over any period of time. This information does not constitute investment research as defined under MiFID.