Central banks across the globe are tightening monetary policy to curb the highest inflation rate in more than four decades. It’s been a rough ride for consumers – food and living costs have soared, as well as the price of energy. In late July, the US Federal Reserve – which, due to its influence, is a benchmark for the health of the global economy – hiked interest rates by 0.75 percentage points to tame surging prices. America’s economy has waned over the last six months, signalling the start of a recession. Many other countries will fall victim to similar downturns.
For business, inflation can be a double-edged sword: some industries are adversely affected by inflation, while others are more likely to benefit. For example, oil companies are making record profits, as the Ukraine war has driven up energy prices and contributed to rising inflation. Aircraft leasing and investment have felt both the positives and negatives. The sector has been hit by rising fuel costs, driven partly by rising oil. But in an inflationary environment, investment in real assets – such as aircraft – may prove to be an effective hedge against inflation.
The economic turmoil looks set to continue, and many economists believe inflation hasn’t peaked yet. We often talk about consumer inflation, but the elephant in the room is how inflation and rising input costs will impact businesses and industries. There has been enormous pressure on corporate balance sheets and investor returns, as borrowing costs have risen and businesses have lost confidence in their capital. While some investments suffer as prices rise, others excel. Aircraft – both the physical planes and the leases and loans used to purchase them – is an investment class that should do well in a high inflation environment.
Aircraft leasing first emerged in the mid-1970s at a time of high inflation. Back then, many investors found the space attractive because it was seen as a hedge against inflation, which rose as high as 14.4% and was only contained in the early 1980s.
Due to the establishment of major lessors – including Guinness Peat Aviation (GPA) and ILFC – in the mid-70s, as well as a favourable tax landscape, Ireland’s leasing industry boomed, and Dublin became the global hub for the sector. At the time, investors were lining up to enter the market and they continue to do so now, as confidence in the aircraft leasing business grows globally. There are still many opportunities – whether for fixed income funds, pension funds, or retail investors – to benefit from investing in aircraft through ABS.
Around half of all commercial aircraft are leased by airlines around the world. Typically, aircraft are leased for up to 12 years from aircraft lessors, in return for monthly or quarterly lease payments. The other costs of operating the aircraft – for example, fuel, crew, maintenance, and insurance – are for the account of the airline. Airlines are attracted to leasing as it gives them operational flexibility and they don’t need to commit to large capital sums years before an aircraft will be delivered.
Lessors finance the purchase of aircraft through a variety of different methods, including ABS. These popular financings enable lessors to raise money against a pool of aircraft leased to different airlines. In recent years, ABS has become more popular, as lessors have been able to raise money at more attractive rates and the capital markets have shown an appetite for the sector.
At ABL Aviation, we see aircraft ABS as an attractive opportunity for those looking to make a smart investment that will mitigate against some of the worst impacts of inflation. Tangible assets – such as aircraft and real estate – tend to increase in value during inflation, whereas intangible assets – like stocks and bonds – tend to be less stable investments.
Physical assets are often less impacted by inflation as they can generate consistent and attractive risk-adjusted returns. Inflation-based price rises positively impact the value of aircraft as they age, slowing depreciation. Furthermore, they provide a steady stream of income through monthly lease rental payments. ABS transactions also see limited sensitivity to changing interest rates, as they are mainly floating rate securities.
But as the American economist Edgar Fiedler once said, there’s no such thing as a riskless hedge against inflation. Rising rates may make businesses less poised to take the risk, borrow or sell their assets.
Prices are expected to continue rising for some time, but the appetite for travel remains strong post-pandemic and many travelers haven’t yet been sensitive to rising costs. There remains a strong demand for both commercial and freight aircraft, which were instrumental in delivering key goods – such as food and PPE – during the pandemic.
Investing in aircraft ABS allows exposure to an asset that will benefit from inflation – by generating monthly rental income from a diversified pool of airlines and aircraft. Although aircraft values depreciate over time, inflation will also offset the decreased resale value of the aircraft, meaning an investor looking to sell it may be able to do so at a higher price.
The market for securities backed by leases and loans for aircraft quickly bounced back after Covid-19. Now is the time for more investors to take advantage of this inflation hedge.
Source: Structured Credit Investor