Factor funds: how to invest with peace of mind

In Brazil, 80% of the banking sector is made up of four banks. These traditional institutions can often be reluctant to extend new lines of credit – a problem that has intensified in the wake of COVID-19 and the subsequent economic recession.

Under such circumstances, it can be particularly difficult for small and medium-sized enterprises (SMEs) to gain access to capital. But alternative financing solutions are helping to breathe more cash into the market. These accounts-receivable trade options are also an interesting opportunity for investors.

One of these alternative financing options is called factoring. A factor is an intermediary agent—an investment fund—that provides cash or financing to a company by purchasing its accounts receivable (expected future payments from customers).

Let’s say a steel producer called Atlantic Metalworks (the supplier) signs a contract with Global Construction (its customer), with the following terms: Atlantic Metalworks will deliver 100 tons of steel to Global Construction on a given date, and three months later, Global Construction will pay Atlantic Metalworks $100,000.

If Atlantic Metalworks needs access to that capital, it can go to a factor fund—a fund put together by investors—and sell them that future asset. The factor fund charges commission and a fee, and gives Atlantic Metalworks the remaining $91,000 in cash. The steel producer can use the capital immediately and put it towards future projects or current operating expenses to grow sales. And three months down the line, the factor fund will hypothetically collect the $100,000 payment.

A similar but distinct solution here in Brazil are funds called Fundo de Investimento em Direitos Creditórios, or trade receivables investment funds (FIDCs). These funds were created in 2001 to facilitate financing in the country and are designed to return fixed interest rates to investors. Like factoring, FIDCs also trade accounts receivable from suppliers, but with several key differences.

Put simply, FIDCs are funded by professional investors, are more strictly regulated, carry a lower tax burden, and are more focused on fostering a long-term relationship with suppliers, when compared with factor funds. FIDCs’ high level of transparency and accountability make them particularly attractive for both investors and suppliers.

In both scenarios mentioned above, there’s a risk that the customer does not pay the $100,000 invoice (or whatever the amount may be). That’s where a credit insurer can plug into this process to make it more reliable.

A credit insurer can support the market by covering the possibility of default (protracted default or insolvency) of the customers listed on the invoices traded by the FIDCs. For each customer, Allianz Trade assesses its creditworthiness to determine the risk of non-payment as per the requested credit limit amount. If we determine that the company is creditworthy, we provide a credit limit decision stating that coverage is valid up to a given amount until further notice. From that point on, the FIDC, and thus the investors behind it, can then have peace of mind knowing they are protected if the customer fails to pay the invoice as planned.

Each time Allianz Trade provides credit insurance to investors, we are also playing a key role in getting more cashflow into the economy. And that is a win-win for everyone that I am proud to be part of.