In Part One of, “The Case for Investing In Canada – World Leaders in Your Backyard”, Greg Cohen provided an interesting analysis and history regarding Alimentation Couche-Tard. For Part Two, Richard Roth, who is responsible for the Financial and Utilities Sectors on Team Canada will do the same for Brookfield Asset Management. While the name “Brookfield” is well recognized by Canadians, their reach and reputation spans the globe and represents yet another world leader in our backyard.
Company: Brookfield Asset Management (TSX: BAM.A)
Canadian Equity Analyst: Richard Roth, CPA, CA, CFA
A global leader in alternative asset management that is poised to take advantage of the rapidly growing demand for its products in renewables, infrastructure and private equity/credit.
Depending on your involvement in the investment industry, you might only know Brookfield by the signage outside its numerous A-class office buildings in downtown Toronto, New York, Boston and Calgary, but the company is so much more than just an owner/operator of office buildings. From humble beginnings as the remains of the fallen Brascan empire, Brookfield has grown into one of the largest providers of investment products for clients that want access to alternative assets and all the benefits that come with that (i.e. potentially higher risk-adjusted returns and diversification). Are you an institutional investor or a high-net-worth individual investor? Do you want to invest in Brazilian solar projects or Indian telecommunication towers? Brookfield would be the first place you would call.
Brookfield was not always the alternative asset management giant it is today. Its history traces its roots all the way back to a Brazilian hydroelectric plant owner more than 100 years ago. Prior to the turn of the last century, Brascan, the largest Canadian company at the time, was beginning to fall apart. A handful of bright accountants stepped in to turn the business around, rationalize its investments and refocus its efforts on cash generation. One of those accountants was Bruce Flatt, who rose through the ranks of Brascan in the 1990s. Mr. Flatt was instrumental in reshaping Brookfield (renamed in 2005) from an investment holding company into an investment manager who would not only manage its own capital, but also third party capital (for a fee of course).
Mr. Flatt’s biggest coup was being one of the first to recognize the importance of alternative assets. This is particularly true for infrastructure assets, such as railways, ports and roads, and the above-average return that those assets could generate for his company and third party investors. He aggressively built out Brookfield’s capabilities in this burgeoning business, beating out competitors like Blackstone, KKR and Apollo, to be the go-to name for investors. $1 invested in Brookfield in 2000 would be worth $25 today. Since Mr. Flatt took over as chief executive officer in 2002, Brookfield has produced an average compounded return of 19% annually.
Since the turn of the century, we have seen a seismic shift in the asset management industry. Investors are increasingly turning from traditional equity and fixed-income products in favour of alternative and real asset investments. This has been especially clear in institutional pension plans, which increased from a 5% allocation to alternatives in 2000 to 25% currently. This means hundreds of billions of dollars are moving out of bonds and equities and are seeking a competent manager who can provide high-returning alternatives. Brookfield has been one of the primary beneficiaries of this trend which, with industry experts estimating penetration as high as 60% by 2030, is expected to continue. Case in point: The largest pension fund in the U.S., CalPERS, has gone from having zero investment in alternatives (excluding real estate) in 2000 to allocating more than 10% today.
WHAT IS DRIVING THIS TREND TOWARDS ALTERNATIVE INVESTMENTS AND IS IT SUSTAINABLE?
There are a whole host of reasons why alternative assets are gaining traction, but the single greatest reason would be declining interest rates. Many institutional investors have historically had asset allocation mixes that encompassed 30%, 40%, or even 50%+ of the portfolio to be invested in fixed-income instruments. While this was viable 25 years ago when the Federal Reserve rate was 6%, it is far more difficult to fund liabilities in an environment where interest rates are effectively zero. Pension and sovereign wealth funds are desperate to hit their internal return targets, which are often in the high single digits and are switching from 2% corporate bonds into 6 or 7% de-risked real estate and infrastructure assets. Why buy a BBB bond that yields 3% when you can buy a stake in a defensive toll road with similar risk parameters that yields 7%?
WHY IS BROOKFIELD BEST POSITIONED TO TAKE ADVANTAGE OF THIS TREND?
While some institutional investors have built up the internal talent necessary to make some alternative investment decisions in-house, most simply lack the resources to have investment experts and operational knowledge in each of the different alternative asset classes. Most cannot afford to have a staff of people dedicated to analyzing and operating hydroelectric assets in Colombia and another focused on self-storage facilities in China. Given its scale, Brookfield can afford to keep experts that know which investments to invest in and which to avoid. Their scale and operational expertise across different asset classes are additional tools in taking advantage of large or complex opportunities, which many competitors simply cannot. Brookfield has the added advantage in that they have been in this game longer than most, having spun out its publicly traded infrastructure fund (Brookfield Infrastructure Partners) 12 years ago, long before most other managers even considered building out capabilities in alternatives.
WHAT DOES THIS MEAN FOR BROOKFIELD SHAREHOLDERS?
By owning Brookfield on behalf of clients, we, as shareholders, are able to earn an average fee of 1.15% off of the nearly $300 billion that the company currently manages and benefit from the continued growth in that fee base to potentially over $500 billion in five years. Investors also benefit from Brookfield’s $25 billion equity interest in its publicly listed subsidiaries who, on average, have returned approximately 8% over the past three years. Finally and least understood by the market, Brookfield is sitting on a hidden war chest of unrealized carried interest earnings, which it earns based on the performance of its funds. Currently the company is realizing well under $1 billion annually, but over the next 10 years, total realization could grow to $20 billion (40% of Brookfield’s current market capital). All this to say that, as things stand today, we believe Brookfield has clear visibility to grow earnings at 15%+ annually for the next number of years and would expect the share price to reflect this growth.
FEE REVENUE BY INVESMENT TYPE
Source: Brookfield Asset Management as at June 30, 2020. S
FEE BEATING CAPITAL
Source: Brookfield Asset Management as at June 30, 2020.
In summary, Brookfield is a world leading global business whose head office and chief executive officer happen to also sit right on top of the Hockey Hall of Fame here in Toronto; what could be more Canadian than that?
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Published November 18, 2020