Increasing stability across sectors
Andrian R. Dacy
Even as global transportation investments have grown in size and stature, the real asset class remains little known to institutional investors. Driven by decades of globalization, the diversity of transport assets has increased dramatically. Ranging from vessels and aircraft to rail and trucking, transport assets are integral components of global trade. While certain transport assets provide attractive opportunistic returns, a significant part of the market is core-plus—characterized by capital-intensive, stable, income-generating assets, contracted over long periods to high quality end users. The core-plus transport investment is a welcome environment for investors looking for reliable income protected by long-term leases, low leverage and the financial strength of high quality end users.
One compelling aspect of the core-plus transport sector is its end user (lessee) profile. While the transport market may be buffeted in the short term by trade tensions, regulatory changes or movements in demand, core-plus transport is protected from such vicissitudes by the balance sheets of its lessees, including energy majors, multinationals and airlines, among others. With lease durations ranging from five to 15 years, over the course of the lease a core-plus transport investor relies on the credit profile of the lessee and is insulated from market volatility.
Modest trade war impact
For a core-plus investor, monitoring the impact of market developments is an important risk assessment. The trade war has had a less severe impact on seaborne trade than many expected—with an estimated 0.5% decline in global seaborne trade for 2019. Of the three main shipping sectors (dry, wet and container), the dry cargo sector experienced the most significant fallout, as tariffs disrupted trade in agricultural products. Overall, substitutions in the supply chain mitigated the impact of the trade war (EXHIBIT 1), as we anticipated in our 2019 Global Alternatives Outlook. For example, instead of shipping soybeans from the U.S. directly to Asia, agricultural suppliers first shipped soybeans to South America, where they were mixed with South American soybeans and then transshipped to Asia.
In a similar fashion, some manufacturers moved operations out of China into Vietnam and other Southeast Asian markets. One result: Container trade from Southeast Asia to the U.S. increased over 30% in the first nine months of 2019 vs. a 7% decline in container trade from greater China to the U.S.
New cleaner fuel regulations in 2020
As of January 1, 2020, a new International Maritime Organization regulation requires ships to meet more demanding fuel emission standards. To comply, vessels can either switch to low sulfur fuels or they can install exhaust gas cleaning systems (scrubbers) to reduce their emissions of sulfur oxide and nitrous oxide.
Over the past year, ships have been taken out of the market to install scrubbers. We expect these trends will continue in 2020, reducing industrywide supply growth and providing support for rates. We also anticipate that a number of older, less fuel-efficient ships will be demolished, further limiting supply. Finally, we project that average vessel speeds will slow to reduce fuel consumption. Such decreases in vessel speeds lead to supply contraction as vessels take longer to complete voyages, thereby supporting market rates.
Supply chain substitutions have mitigated the impact of the trade war
EXHIBIT 1: WORLD SEABORNE TRADE GROWTH BY SEGMENT, 2010–20
As a core-plus investor, we focus on modern, fuel-efficient vessels; these are the most attractive to lessees with long-term, ESG-focused transportation requirements.
Continued stability in aircraft leasing
The aircraft leasing sector provides a clear example of the stability of core-plus transportation investing. Even in the depths of the financial crisis, when airline profits plummeted, aircraft lessor operating margins remained stable (EXHIBIT 2).
Long-term aircraft leasing contracts insulate a lessor from potential fluctuations in asset values and rates during periods of market stress. A core-plus transport portfolio will focus on quality counterparties, young aircraft and long term leases—airlines’ first leases typically run up to 12 years. The long duration of these leases provides an attractive, diversified source of income.
Aircraft leasing (core-plus transport) has remained remarkably stable, even through the global financial crisis
EXHIBIT 2: VOLATILITY ANALYSIS*
By focusing on capital-intensive assets, critical to the long-term requirements of high quality, often investment grade end users, core-plus transport investors can secure long-term, high single digit current yields over lease periods of five to 15 years.