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:
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."
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.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of BAMR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling shares, you should do your own research and reach your own conclusion, or consult a financial advisor. Investing includes risks, including loss of principal.