Low interest rates have left many investors yield-starved, with private single and multifamily offices now looking at alternative investments in the hope of higher returns. Private equity, infrastructure and property have so far provided family office executives with a bright spot in an otherwise rather gloomy environment. But aircraft financing, with infrastructure-like features and strong liquid collateral also has a compelling investment case for investors looking for attractive returns on a risk adjusted basis.
With nearly 20 years specialising in aircraft finance and over US$ 10 billion of deals secured, industry expert and head of Investec’s Aviation Team, Alok Wadhawan, shares his insights into the sector.
Why are investments in commercial aircraft attractive and what has attracted investors to this asset class?
The main benefit is the attractive risk-adjusted returns available and the solid cash yield generation. Also, aircraft are highly mobile assets and can, therefore, be allocated globally where there is the most demand, unlike property for example.
Furthermore, asset values are highly predictable: there is an increased demand for aircraft due to global growth in airline traffic, while supply is concentrated in a handful of manufacturers.
The stability of the underlying cash flows (lease payments) and the ‘alternative’ nature of the asset class lend itself to investors seeking attractive and non-correlated returns. The stable and predictable cash flows generated in the sector are similar in nature to rental payments in real estate.
These returns are generally based in US dollars. Investors achieve annual cash dividends of 8% with upside potential in the overall return (IRR) based on the aircraft value at the end of the investment period in the range of 12-17%.
Additionally, due to the low correlation to the equity and bond markets, aircraft investments can bring some interesting diversification benefits to a portfolio, especially during times of financial asset distress.
Who has invested in aircraft risk and where does the asset class sit within a portfolio?
Typically some of the largest global asset managers, public and private pension funds, insurance companies and sovereign wealth funds, but also family offices and even some individual investors. Essentially, as more and more investors see the benefits of the asset class and its associated returns, we see an increase in the global investor base.
These assets can sit in different pools: private debt, multi-asset, alternative or high yield portfolios.
What are the risks associated with aircraft investments?
The risks of investing in aircraft backed assets falls into four separate categories. These are ‘credit’ risk (that of the airline paying the monthly lease rental), the ‘asset’ risk (how to maximise the future value of the aircraft), the jurisdictional risk (the legal jurisdiction/framework under which the airline/asset operates) and finally the liquidity risk of the investment.
Typically Investec engages with the world’s top airlines but analysing the credit risk is for us the most important part of the investment analysis.
Asset (aircraft type and age) selection is also an important factor to consider when determining the stability of and certainty of the future value. Expert agencies provide detailed valuations of the aircraft’s expected future values. In addition we rely in our own trading activity in the sector to have a good sense of aircraft values. In spite of the aircraft loss of value due to depreciation, loan repayments are quicker than asset depreciation and the leverage reduces over time.
In addition to the jurisdictions covered by the Cape Town Treaty, Investec undertakes a full legal due diligence on any new jurisdiction we engage with.
Liquidity of the investment: some investment opportunities in this sector are via listed equity funds. However, our investments tend to be private, non-listed instruments. We prefer to get higher returns from an illiquidity premium rather than from older assets or weaker airlines.
What experience does Investec have in originating and structuring aircraft investments?
Investec’s Aviation Finance business started over 15 years ago. Since then we have been working closely with many of the world’s top airlines and leasing companies and we currently manage aircraft assets worth circa $7bn. These assets are managed on our balance sheet and via the aircraft leasing and aircraft debt portfolios we manage on behalf of institutional investors.
In addition to our financing expertise and our in-depth knowledge of the aviation sector, we have in the team technical and remarketing capabilities. This differentiates us from other banks and enables us to provide innovative investment opportunities for investors.
Have you examples of investments in aircraft?
We mainly finance Boeing and Airbus commercial aircraft (typically Boeing 737/777/787 and Airbus A320/330/380 aircraft) in their first and second lease cycles. The predictable values at the end of the leases on these key aircraft for airlines allows for stable returns on our investments.
Investec regularly originates deals with major airline companies. Some recent examples include five Airbus A380s on lease to Emirates Airlines, three Boeing 777s on lease to American Airlines and five Boeing 787s on lease to Air India. These deals typically provide investors with high single digit annual cash yields and expected IRRs in the mid-teens upon the sale of the aircraft.
As well as investment opportunities backed by single aircraft, Investec does manage a number of funds which combine different aircraft and different airline operators. For example, Investec manages 3 equity funds with over 100 aircraft, predominantly Boeing 737 and Airbus A320 narrow-bodied aircraft. These investments generate cash yields of 6-8% per annum and we have a successful track record, back to 2008, in managing these funds. The total asset value in these equity funds is c.$5.5bn. As well as managing equity funds, we also manage $1bn across 3 separate debt funds. In these funds, the return, net of fees, is around 4%.
Very importantly for our investors, Investec always participates alongside them through a co-investment on its balance sheet, hence ensuring the strongest alignment of interest between Investec and investors.
How can investors increase their knowledge in this sector?
Aircraft financing is now an established alternative asset class with a wide range of institutional investors. However, there are investors who do not have either the specialist knowledge required to invest in this sector.
For this reason, we like to share our in-depth expertise in the sector to educate potential new investors. For example, we are hosting an aircraft investment seminar on 24 November to provide investors with updates on the sector and insights into the specifics of investing in aircraft.
For a more tailored approach to specific investment requirements, we also organise one-on-one meetings to highlight the range of investment opportunities available.
For further information please don’t hesitate to contact us.
Aircraft Investment Seminar
Thursday, 24 November
To attend, please contact Mark Rogers
Tel: 020 7597 5755 — email@example.com
Head of Aircraft Finance
Tel: 020 7597 3652
Aircraft Asset Distribution
Tel: 020 7597 5755