Brookfield Asset Management (NYSE: BAM) is a leading global alternative asset management firm that we believe will benefit from the inflationary environment for the following reasons:
- Most contracts in their renewable energy and infrastructure businesses have built-in inflation adjustments.
- Their the debt is mostly fixed interest, which in many cases will produce a negative real interest rate during times of high inflation, meaning the company will effectively be paid to borrow, so to speak.
- The majority of the value of its assets should adjust quickly to inflation, given their high-quality nature and the fact that they are mostly real assets such as power generation and transmission , real estate and infrastructure.
- The expansion of the money supply creating much of the inflation that we are currently seeing means that there is more money to invest, providing tailwinds for the asset management business.
- The company is expected to gain a competitive edge over its debt- and equity-focused asset management rivals, as real assets are more likely to hold up to inflation. Bonds in particular will be at a clear disadvantage, as many fixed income assets will experience negative rates of return during periods of high inflation.
Inflation resulting from a flow of money
As monetary economist Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.” And we can understand why inflation is currently very high and likely to persist for some time by looking at how much M2 money supply has increased following the COVID crisis. can normally absorb ~6% growth in M2 money supply without too much trouble and maintaining inflation at ~2%, but M2 growth having peaked at 24% in 2021 and still at ~11% today oday, we can expect high inflation to be with us for some time. That’s why it’s so important that investors choose wisely where to put their money over the next few years. Since some businesses will suffer significantly from high inflation, others will be relatively immune, and some may actually benefit. We think BAM is actually in the latter camp.
By comparing BAM’s revenue growth rate with the US inflation rate, we can see a correlation. Over the past ten years, this correlation has varied, but averages around 0.30, which is not negligible and reaffirms our belief that revenue grows faster in times of high inflation for BAM. .
Looking at absolute earnings growth rates, we can understand why stocks have performed so well. Revenues have increased by nearly 20% CAGR over the past decade, although some of it (circa 2018) is due to the purchase of Oaktree.
One of the reasons Brookfield is growing so rapidly, particularly its asset management business, is that investors around the world are increasing their allocations to alternative investments, in which Brookfield specializes. The average allocation for institutional investors is estimated to have increased from 5% in 2000 to ~30% now, and is expected to double to ~60% by 2030.
This increased allocation to alternatives should result in a significant increase in fee-earning capital for the company. It should grow even faster than the allocation increases, thanks in part to the increase in the money supply that we talked about above. One thing that differentiates Brookfield from other asset managers is that no other company has invested as much capital alongside its investors as Brookfield.
Inflation should also stimulate the new insurance business the company is creating. The company is essentially betting that it can earn more on the “float” capital than the insurance companies assumed they could generate. As inflation forces interest rates to rise, it should be much easier to generate higher rates of return on this capital. So far, the company has taken $45 billion in insurance AUM by reinsuring policyholder liabilities and long-term fixed annuities. Some of the deals the company has signed so far include American Equity, American National, and RGA. We go into much more detail about this new company strategy in our article, “Brookfield Exits from Buffett’s Playbook.”
Favorable Winds for Real Asset Inflation
As already mentioned, BAM has a big advantage over other asset managers in that it specializes in investing in real assets. This includes buildings, communication towers, toll roads, railways, pipelines, solar power plants, wind power plants, hydroelectric assets, etc.
These real assets have the added advantage that in many cases their cash flows can adapt quickly to inflation or their contracts are indexed to inflation. For example, the renewable energy sector has ~70% of its contracts indexed to inflation:
Similarly, the infrastructure business has about 70% of its funds from operations (FFO) with contractual or regulated inflation adjustments.
We have already seen why Brookfield can benefit from inflation, but can it grow faster than inflation? The company has a number of tailwinds that make us believe it actually can. In addition to the already discussed increased allocation to alternatives, there are a few additional reasons why the business can grow rapidly. These include governments having to sell infrastructure assets to pay for stimulus, data infrastructure in need of an upgrade, severely bottlenecked transmission assets, and most importantly, the need for decarbonization to stop climate change, a generational scale investment opportunity.
To capitalize on all of these growth opportunities, the company has a very strong balance sheet that it can leverage if necessary, with $5.5 billion in cash, unused credit facilities and access to significant funding. . In relation to its assets, the company is very little indebted and its current indebtedness is low.
We believe BAM’s 2 closest competitors are Blackstone (BX) and KKR & Co. (KKR). While we believe all three asset managers can benefit from some of the tailwinds discussed in this article, compared to Blackstone, BAM is much more reasonably priced and should benefit from inflation more than KKR thanks to its increased focus. on real assets.
Brookfield’s compound annualized return has been around 20%, and we believe the company can continue to generate these types of returns given the amount of tailwinds it is likely to enjoy. These tailwinds include inflation, thanks to its focus on real assets funded primarily by fixed rate debt. The new insurance business should help drive growth, and the company’s strong balance sheet should also help it take advantage of opportunities and provide downside protection.