The First Independent Total Return Index for the Trade Finance Market

Why have an Index?

Without a benchmark index there is no easy means to compare or benchmark performance to support quantitative asset allocation decisions that may include trade finance assets. Participants in the trade finance market have long appreciated the attractive features of trade finance assets, comprising low price volatility and the credit risk comfort derived from countries' reluctance to reschedule their trade payment obligations, combined with interesting yields. However, until now it has been difficult to obtain the hard figures to substantiate these assertions. The LTP Trade Finance Index"! quantifies the performance characteristics of the trade finance asset class. Using the LTP Trade Finance Index"!, it is now possible to compare the risk and reward of the asset class with others.

This information is particularly vital to new investors in trade finance, who base asset allocation decisions on relative performance and risk across markets.

How is the Index Constructed?

The LTP Trade Finance Index"! is a weighted index based on the debt obligations of emerging market borrowers issued to support international trade, expressed in United States Dollars. The index is constructed in such as way as to replicate the performance of a representative portfolio of trade finance assets.

Countries are included in the index on the basis of the availability and liquidity of trade finance assets issued by prime obligors in that country. Countries are weighted within the index by reference to the total international trade of that country as published by the World Trade Organisation, with a further adjustment reflecting the depth of the secondary market.

The country weightings as at the beginning of 2001 are illustrated below.

The value of the LTP Trade Finance Index"! is calculated with reference to: i) the credit margin of USD denominated trade finance assets with maturity of one calendar year; and ii) matching underlying USD LIBOR rates (by reference to the British Bankers' Association Interest Settlement Rates). The credit margin for each country is determined for each calculation date from the clearing prices at which trade finance assets are traded on the LTPtrade.net dealing platform, augmented where necessary by a poll of leading participants within the trade finance market. The index has a duration of one year.

The compiler of the LTP Trade Finance Index"! is LTP Risk Management, part of the LTP Trade group. The compiler has appointed a steering committee responsible for making periodic adjustments in accordance with the index rules, with the general aim of ensuring that the weighting and selection of the component countries remain at all times the best possible representation of those available in the trade finance market for investment purposes. The steering committee is also responsible for the integrity of the data and the calculations.

The index is calculated for the close of business every Friday and for the last business day of each calendar month. Performance is split into interest accrual (credit margin and LIBOR) and capital performance. The running credit margin over LIBOR is also calculated.

How has Trade Finance Performed?

An index reflects the financial performance of the underlying asset class. It also enables cross-market comparisons of performance to be made.

The chart below sets out the relative performance of trade finance assets as measured by the LTP Trade Finance Index"! against other industry benchmarks:

Trade finance assets clearly offer an excellent risk/reward profile, giving a high average return for a low level of volatility. In fact, over the period 1998 to 2000, the LTP Trade Finance Index"! has produced returns close to those on emerging market bonds (JP Morgan EMBI+ Index) but with much lower volatility, and otherwise was beaten on return only by the FT World Equity Index, which also had a much higher volatility of returns.

In January 2001 the index returned 1.3%, of which 0.7% was capital appreciation and 0.6% interest accrual.

The LTP Trade Finance Index"! can also be used to illustrate relative performance over time using the running credit margin:

Summary

A transparent benchmark index is important for the health of an asset class. The LTP Trade Finance Index"! can be used to as a reference point for traders and risk managers and as a benchmark to enable new investors in trade finance to make quantitative asset allocation decisions. By having an index of this nature, trade finance assets can obtain equal status with more widely held asset classes such as bonds.