A look into the asset leasing sector
Mayank Markanday of Architas explains what he believes are the benefits of alternative investments. Here he reviews the aircraft leasing sub-sector.
In the wake of the financial crisis, and against a backdrop of ultra-low interest rates, the traditional asset classes of bonds and equities had several years of largely positive performance. In 2018, though, markets were less accommodating.
In the 12 months to 31 December 2018, the FTSE All-Share index had total returns of -9.47%, while the Markit iBoxx £ Non-Gilts index returned -1.53%.1 These statistics would appear driven by factors such as the US-China trade dispute, the threat of US interest rate rises, and uncertainties over the Brexit outcome and Italy’s commitment to the European Union.
Alternatives, however, can behave differently to traditional asset classes. In our view, this can make them good for investment diversification.
Alternatives can include any assets outside the traditional asset classes of shares, bonds and cash. These can include investments in aircraft leasing, absolute return funds, infrastructure, specialist property and gold.
Gold can often be negatively correlated with equities, making the precious metal a useful asset for investment diversification. This highlights the fact an alternative investment can work well in economic scenarios in which a traditional asset class might underperform.
What do we like right now?
We are positive on the alternative assets sub-sector of aircraft leasing, a type of asset leasing that sits in the real assets category of alternative investments. Aircraft leasing has yields of around 7.5%, which look attractive in the current low interest rate environment, and the investment is backed by physical assets and has strong lessee counterparties. Unless the counterparties fail, the investments will receive high single-digit total returns over the course of their lives, even under a bearish scenario for plane residual values.
Aircraft leasing offers airlines some key benefits. In particular, it reduces their capital commitments and offers operational flexibility.
Air traffic, measured by revenue passenger kilometres (RPKs), has grown by an average 6.0% a year since 2008.2 Global economic development and air passenger traffic grow together, with the highest traffic increases occurring between emerging markets. According to the International Air Transport Association (IATA), in 2034 emerging markets are expected to account for 70% of global RPKs.
RPK growth in 2017 was a very healthy 8.0%. But this is estimated to have fallen to 6.5% in 2018, while forecast growth for 2019 is 6.0%,3 reflecting concerns over global growth. Reassuringly, in the latest IATA January survey,4 85% of survey respondents expect demand growth to rise in 2019.
Moreover, residual values of aircraft are stable over time and not prone to significant cyclical fluctuations, while aeroplanes have long useful lives. There is also a high order backlog for aircraft, with production outpaced by demand. At 31 October 2017, for example, there were 680 firm orders for the Airbus A350-900.5
Despite these advantages, aircraft leasing funds face the risk of default from the airlines they lease to. But the aircraft leasing funds held in the Architas Diversified Real Assets Fund lease to established long-haul airlines, including Emirates. This does not eliminate the risk of default, but it does give some reassurance they will be able to meet lease payments. In any case, aeroplanes can be re-leased to other airlines in the event of a default.
These types of investments can also face exchange rate risk, as they are exposed to fluctuations in the value of sterling against the US dollar. But the funds we hold receive rental payments in a combination of sterling and US dollars, to meet the needs of UK investors and of debt-holders requiring dollar payments. Even so, re-leases of sales of aircraft remain exposed to the US dollar-sterling exchange rate.
Investors face a challenging environment. In particular, we think equities could be hit by low economic growth. Real assets can offer returns with low correlations to equities and bonds.
We have maintained a relatively steady allocation to asset leasing, in the form of aircraft leasing, in the Architas Diversified Real Assets Fund. This is because it offers attractive yields while also offering relatively low volatility and low correlation to traditional asset classes. We believe this will be beneficial given our outlook on the return of volatility to the markets.
Issued by Architas Multi-Manager Limited
1Morningstar Direct, January 2019.
2IATA Air Passenger Market Analysis, November 2018, 10 January 2019.
3IATA Industry Statistics, December 2018.
4IATA January 2019 Survey, 24 January 2019.
5Ascend as at 31 October 2017.
This is for professional clients only and should not be issued to or relied upon by retail clients.
Past performance is not a guide to future performance. The value of investments, and any income, can fall as well as rise and is not guaranteed. Some of the fund’s portfolio is invested in non-mainstream assets, which during periods of stressed market conditions may be difficult to sell at a fair price, which may in turn cause prices to fluctuate more sharply than usual.
Architas Multi-Manager Limited (AMML) is an investment company that provides access to other investment managers’ services through a range of multi-manager solutions, including regulated collective investment schemes. AMML in the UK works with strategic partners and AXA Group internal fund managers, to find out more information about this please visit architas.com/inhousestratpartners/
AXA is a worldwide leader in financial protection and wealth management. In the UK, one of the AXA companies is Architas Multi‑Manager Limited, an investment company that provides access to other investment managers’ services through a range of multi-manager solutions, including regulated collective investment schemes. Architas Multi‑Manager Limited is a company limited by shares and authorised and regulated by the Financial Conduct Authority (Firm Reference Number 477328). The company is registered in England: No. 06458717. Registered Office: 5 Old Broad Street, London, EC2N 1AD.