Brookfield Wealth Management (NYSE: BAM) is a leading global alternative wealth manager that we believe will benefit from the inflationary environment because:
- Most contracts in their renewable energy and infrastructure businesses have built-in inflation adjustments.
- Her Debt is mostly fixed rate, which in many cases yields a negative real interest rate during periods of hyperinflation, so that the company is actually being paid to borrow, so to speak.
- The value of most of its assets should adjust quickly to inflation due to their high quality and the fact that they are mostly physical assets such as power generation and transmission, real estate and infrastructure.
- The expansion of the money supply, which is causing much of the inflation we are currently witnessing, means more money can be invested, giving the wealth management business a tailwind.
- The company should gain a competitive advantage over debt- and equity-focused wealth management rivals, as real assets are more resilient to inflation. Bonds, in particular, will be at a clear disadvantage as many fixed income investments will post negative yields during periods of high inflation.
Inflation due to the flood of money
As monetary economist Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.” And we can understand why inflation is very high right now and is likely to continue for a while if we look at how much the M2 money supply is changing after the COVID crisis. The economy can normally absorb ~6% M2 money supply growth without too many problems and keeps inflation around 2%, but M2 growth has peaked at 24% in 2021 and is still lagging today still at around 11%, so we can safely assume that the high inflation will continue for some time over the next few years. Because some companies will suffer significantly from high inflation, others are relatively immune, and some may even benefit. We believe that BAM is indeed in the latter camp.
Comparing BAM’s revenue growth rate to the US inflation rate, we see a correlation. Over the past decade, this correlation has varied but averages around 0.30, which is not negligible and reinforces our belief that BAM’s earnings grow faster during periods of high inflation.
If we look at absolute sales growth rates, we can see why the stock has performed so well. Revenue has grown at a nearly 20% CAGR over the past decade, though some of that (circa 2018) can be attributed to the Oaktree purchase.
One reason Brookfield’s rapid growth, particularly its wealth 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 grown from 5% in 2000 to around 30% now and is projected to double to around 60% by 2030.
This increased allocation to alternatives should result in a significant increase in the company’s chargeable capital. It should grow even faster than the allotment increases, thanks in part to the increase in the money supply discussed above. One thing that sets Brookfield apart from other money managers is that no other company has invested as much capital alongside its investors as Brookfield.
Inflation should also boost the new insurance business the company is building. The company is basically betting that it can earn more on “float” capital than insurance companies have realised. With inflation driving up interest rates, it should be much easier to earn higher returns on that capital. To date, the company has earned $45 billion in insurance AUM by reinsuring policyholder liabilities and long-term fixed annuities. Some of the agreements the company has signed so far include American Equity, American National and also RGA. We go into much more detail about the company’s new strategy in our article titled “Brookfield Takes a Step Out of Buffett’s Playbook.”
Real asset inflation tailwind
As we mentioned earlier, BAM has a major advantage over other money managers because it specializes in real asset investing. These include buildings, communication towers, toll roads, railways, pipelines, solar panels, wind turbines, hydroelectric power plants, etc.
These tangible assets have the added benefit that in many cases their cash flows can adjust quickly for inflation or their contracts are indexed to inflation. For example, in the renewable energy sector, around 70% of contracts are indexed to inflation:
Similarly, the infrastructure business has about 70% of its working capital (FFO) with contractual or regulated inflation adjustments.
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 lead us to believe it actually can. Aside from the increased allocation to alternatives mentioned earlier, there are few additional reasons why the company can grow rapidly. These include governments needing to sell infrastructure assets to fund stimulus measures, data infrastructure in need of an upgrade, transportation assets hit by critical congestion, and more importantly, the need for decarbonization to halt climate change, an investment opportunity for generations.
To capitalize on all of these growth opportunities, the company has a very strong balance sheet to leverage when needed, with $5.5 billion in cash on hand, undrawn credit facilities and access to significant financing. The company has very little debt compared to its assets and its current debt level is low.
We believe that BAM’s two closest competitors are Blackstone (BX) and KKR & Co. (KKR). While we think all three money managers can benefit from some of the tailwinds discussed in this article, BAM is much cheaper relative to Blackstone and should benefit more from inflation than KKR thanks to its greater focus on real assets.
Brookfield’s compound annualized return was ~20%, and we believe the company can continue to deliver those kinds of returns thanks to the number of tailwinds it’s likely to benefit from. One of those tailwinds is inflation, thanks to a focus on real assets funded primarily by fixed-rate debt. The new insurance business should help spur growth, and the company’s solid balance sheet should also help it seize opportunities and protect against losses.