Hard assets that pay reliable income are a pretty good idea at the best of times — especially if you’re not the greedy kind of investor — but right now, they are a bloody good idea. Gross and El-Erian’s “new normal” predicates the ownership of real assets with stable and secure income. Factor in the possibility of Renee Haugeruud’s “inverse stagflation” entailing under-performing traditional paper assets — like stocks & bonds — and soaring real asset values and you get the picture.
That remains the holy grail for me: create a vehicle with real assets that throw off real cash flow, reliably, like clockwork. Then you take that cash and invest it in things with more octane in the return. Of course there may be capital gains but I’ve always considered that part of investing a mug’s game: waiting for everyone else to figure out that I do really have a gold mine — or the bigger fool to come along, whichever comes first. What I care about is the income, then I can put the income into more interesting investments like hedge funds, private equity, power barges in Africa, oil exploration in Iraq, currency bets, gold bets, you get the picture. Played right — and not forgetting risk management — these investments can provide extra returns; natural leverage. If everything goes to hell in a hand basket, there’s always the real assets to fall back on. But there are some very simple rules to follow:
- Pick what you know, not what’s cool right now
- Pick investments that have natural competitive advantages
- Pick something that — as Warren Buffett said of Coca Cola — a “ham sandwich” could run
- It better have free cash flow and low debt
- And never, ever, NEVER use leverage to buy an asset
Did I mention never using leverage? If you forget rule 5, you might as well go home right now.
Infrastructure investment has always been a part of that picture: you buy — hopefully under-valued — real assets that have some sort of utility to the general public. A utility the public is willing to pay for: railroads, utilities, expressways, buildings, hospitals, things like that. They are not very exciting but they make up for that by providing a steady income. For decades. A major innovator in this business was Macquarie Bank of Australia. Starting as the merchant bank Hill Samuel in 1969, it metamorphosed into Macquarie Bank in 1981. According to the FT
Macquarie shot to prominence earlier this decade by pioneering infrastructure investing: bundling assets from toll roads to airports into listed and unlisted vehicles that were managed by the bank in return for a lucrative stream of fees.
550m vehicles travel on its roads; 44m passengers use its airports; and 2.6m containers cross its ports. Its assets supply 7.6m households with gas, 6.5m with water and 4.1m with electricity.
- Look for anything to invest in, after all it’s not their own money
- Lever the crap out of the investment
- Put fees on top of the fees
And Macquarie did all three. The bank was generating fees for the up-front purchase of an asset, selling the assets into the trust/fund and then management and performance fees from the funds. So much so that short-seller Jim Chanos — of Enron fame — warned of the model’s un-sustainability as far back as 2007:
The underlying economics, in my opinion, are flawed. Being the top bidder for these assets and then flipping them into the trusts leads to an unsustainable economic engine at the trust level. And when that breaks down all of the fees and whatever’s being paid begin to break down.
He was making more of a case for shorting the bank’s shares as he considered the income stream from these funds a chimera because of the leverage used and the fact that the bank was using Australian accounting to rules to revalue the assets (so it could borrow against them). But you get the picture: it takes a lot of talent — or an investment bank— to so royally fuck up such a good idea.
Now, faced with plunging asset values and declining incomes (yes, they picked some that would lose money in a declining economy) the bank is rapidly “restructuring” it’s infrastructure funds and getting away from the infrastructure model as rapidly as it can. Expect this to involve spinning off of some of these assets. Vulture funds are already circling the M6 toll operator and Newcastle Airport though I would probably pass on either property but the fund does have some nice infrastructure assets like the French APRR toll road system and Quippo WTTIL (a mobile phone tower network in India) that sound juicy.
Stressed seller — read over-leveraged moron — of good infrastructure assets in growth markets with good cash flow. Yum!
- Macquarie first half profit to fall 25% (news.theage.com.au)
- Macquarie Bank: desperately seeking swagger (ftalphaville.ft.com)
- Everbright, Macquarie to float two infrastructure funds (projectworldawareness.com)
- Government drives forward toll-road scheme to help fill cash gap (guardian.co.uk)