What the Heck is Factoring?

Good day,

As mentioned in previous commentaries, while pension and endowment funds have been investing in alternative investments for many years, retail investors have been in the dark as private debt and equity hasn’t been easy to access in Canada. This is gradually changing with many sources estimating this investment space could double over the next 5 years for retail investors.

Alternative Investments or “Alts” refer to investment vehicles which are generally uncorrelated to the stock and bond market and therefore provide diversification from the more volatile liquid markets. Many Canadians are already investing in Alts by owning one or more real estate properties. While there are many examples of Alternative Investments, I will provide a brief explanation of “Factoring”.

A factor is a funding source for businesses that require immediate capital. The business sells its receivables to the factor, to accelerate the period it takes to receive its funding. A small discount is applied to the purchase price of the receivable which translates into profit for the factor/investor. Here’s an example:

A furniture manufacturer has a distribution agreement with a furniture retailer. The manufacturer produces the furniture and sells it to the retailer. When the manufacturer invoices the retailer, the retailer might have 30-60 days to pay the invoice. This length of time can put financial strain on the manufacturer as it has its own obligations to pay wages, supplies, machinery etc. In order for the manufacturer to access the cash it needs more rapidly, the manufacturer will sell its receivable to the financial intermediary – the factor – at a small discount of perhaps 3% for a 60-day period. The factor receives payment equal to the full amount of the invoice from the retailer, (since it is now the owner of the receivable) and pockets the 3% spread. Many businesses have ongoing relationships with factors and simply consider the “advance”, a price to doing business.

There are many factors in North American which do an excellent job keeping risk low by purchasing receivables from highly reputable and well capitalized companies including many of the businesses we, Canadians, purchase goods and services from. Factors generally purchase many receivables simultaneously to build a diversified pool of receivables.

From an investor’s point of view, diversification is key. An alternative investment focusing on three asset classes was recently launched in Canada. For extensive diversification, the investment vehicle holds private debt, mortgage investment corporations as well as real estate. For further diversifications, 3-5 providers within each of the three asset classes are included in the portfolio mandate.

The target return for this investment vehicle is 7-8% with low volatility, and lengthy track records of the underlying portfolios show such average returns with next to no volatility. Given the rising interest rate environment, Harbourfront clients across Canada, as well as my personal portfolio, continue to build a meaningful allocation to North American private debt and commercial & residential real estate.

Have a good weekend!

Danny

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Daniel Popescu CFP, CIM, FMA, FCSI
President & CEO

MNP Tower, 3100-1021 West Hastings St.
Vancouver, BC V6E 0C3
T: 604-558-6830/1(877) 588-6822
F: 604-558-6823
harbourfrontwealth.com

 

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