Brookfield Asset Management (NYSE:BAM) is a premier global alternative asset management business we believe will benefit from the inflationary environment for the following reasons:
- Most of the contracts in their renewable energy and infrastructure businesses have built-in inflation adjustments.
- Their debt is mostly fixed-interest, which in many cases will be yielding a negative real interest rate during high-inflation periods, meaning the company will actually be paid to borrow, so to speak.
- The majority of its assets’ value should adjust quickly to inflation, given their high-quality nature and the fact that they are mostly real assets such as energy generation and transmission, real estate, and infrastructure.
- The expansion of the money supply creating much of the inflation we are currently seeing means there is more money to invest, providing tailwinds to the asset management business.
- The company should gain a competitive edge over asset management competitors focused on debt and equity, since real assets are more likely to withstand inflation. Bonds in particular will be at a clear disadvantage, since many fixed-income assets will experience negative rates of return during high inflation periods.
Inflation resulting from a flood 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 a while by looking at how much M2 money supply expanded after the COVID crisis. The economy can normally absorb ~6% M2 money supply growth without too many issues, and keep inflation ~2%, however M2 growth having peaked at 24% in 2021 and still being ~11% today, we can expect high inflation to be with us for some time. That is why it is so important investors choose where to place their money wisely during the next few years. As some companies will suffer significantly from high inflation, others will be relatively immune, and some might actually benefit from it. We believe BAM is actually in the latter camp.
Comparing BAM’s revenue growth rate with the U.S inflation rate, we can see a correlation. In the last ten years this correlation has varied, but is around 0.30 on average, which is not negligible and reaffirms our belief that revenue grows more quickly during periods of high inflation for BAM.
Looking at the absolute revenue growth rates we can see why shares have performed so well. Revenue has grown close to a 20% CAGR for the last decade, although part of it (around 2018) is due to the purchase of Oaktree.
One reason Brookfield is growing so quickly, particularly its asset management business, is that investors around the world are increasing their allocations to alternative investments, which Brookfield specializes in. It is estimated that the average allocation for institutional investors has gone from 5% in 2000 to ~30% now, and that it should double to ~60% by 2030.
This increased allocation to alternatives should result in a significant increase in fee bearing capital for the company. It should grow even quicker than the increases in allocation, in part thanks to the increase in money supply that we discussed above. One thing that differentiates Brookfield from other asset managers is that no other company has as much capital invested alongside its investors as Brookfield.
Inflation should also boost the new insurance business the company is creating. The company is basically betting that it can earn more on “float” capital than what the insurance companies were assuming they could generate. As inflation forces interest rates higher, it should be a lot easier to generate higher rates of return on this capital. So far the company has taken $45 billion of insurance AUM by re-insuring policy holders liabilities and long-dated fixed annuities. Some of the agreements the company has signed so far include American Equity, American National, and also RGA. We go into a lot more detail on this new strategy by the company in our article titled “Brookfield Makes A Move Out Of Buffett’s Playbook.”
Real Asset Inflation Tailwinds
As we’ve already mentioned, BAM has a big advantage over other asset managers in that it specializes in real asset investing. This includes buildings, communication towers, toll roads, railroads, pipelines, solar plants, wind plants, hydro assets, etc.
These real assets have an added benefit that, in many cases, their cash flows can quickly adapt to inflation, or their contracts are indexed to inflation. For example, the renewable energy business has ~70% of its contracts indexed to inflation:
Similarly, the infrastructure business has about 70% of its funds from operation (FFO) with contractual or regulated adjustments for inflation.
We’ve 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 few extra reasons the company can grow quickly. These include governments having to sell infrastructure assets to pay for stimulus measures, data infrastructure in need of an upgrade, transport assets critically bottle-necked, and more importantly, the decarbonization need to stop climate change, a generational scale investment opportunity.
To capitalize on all these growth opportunities the company has a very strong balance sheet it can leverage if necessary, with $5.5 billion of cash on hand, undrawn credit facilities, and access to significant financing. Compared to its assets, the company has very little debt and its current leverage is low.
We believe BAM’s 2 closest competitors are Blackstone (BX) and KKR & Co. (KKR). While we think all three asset managers can benefit from some of the tailwinds discussed in this article, compared to Blackstone BAM is priced a lot more reasonably, and should benefit from inflation more than KKR thanks to its higher focus on real assets.
Brookfield’s compounded annualized return has been ~20%, and we believe the company can continue to deliver these types of returns thanks to the number of tailwinds it is likely to benefit from. These tailwinds include inflation, thanks to its focus on real assets financed mostly by fixed-rate debt. The new insurance business should help boost growth, and the company’s solid balance sheet should also help it capitalize on opportunities and provide downside protection.