Recently they have been either buying or bidding for a global company that leases out airport trolleys at airports, an airline leasing company and the London Stock Exchange which sacrilegiously goes under the acronym previously reserved for the London School of Economics (LSE).
The assets very often involve what I think is called in the trade ‘clipping tickets’. Typically the total return is not that far below equity returns, but the yield is much more stable than equity more like property.
And some of these assets end up demonstrating a big (usually one-off) upside. Upon acquisition or after some quaint regulatory protection of the public is swept aside, Macquarie demonstrates that the inherent monopoly characteristics of the asset can be exploited further than had previously been dared. This was the case with Sydney Airport. A journo from the Financial Times rang me and asked for my opinion as to Macquarie’s interest in the London Stock Exchange. I told him my guess was that Macquarie would be interested in further testing the monopoly power of the LSE.
These are two signs of the time for our economy. This post is about the first phenomenon the expansion of demand for assets with very stable yield.
We’ve known of the equity premium for years. Early calculations of an appropriate risk margin for holding equity over government debt using mainstream financial theory suggested the premium should be well under one percent. Yet there’s a persistent difference in annual return of over five percent between equity like and bond like returns. I don’t know what the international literature on property prices and bonds says, but in Australia for a good while now property has performed far better than bonds generally yielding more even before capital gains are considered.
Macquarie’s asset accumulation and management is targeted to a large extent to meeting the demand for assets from the burgeoning superannuation funds that are the legacy of the ALP’s last period in power. And those funds are hungry for assets that have low volatility and which have better performance than bonds. Now the Australian capital market (and Macquarie) are somewhere near the forefront in all this. But it’s going on elsewhere. Other asset classes that are growing fast in the search to lower portfolio risk and/or increase yield are private equity and hedge funds. Hedge fund investment has been expanding at a rapid rate as I think private equity has. Neither class is necessarily low risk on its own, but it can still lower risk in a portfolio by virtue of its capacity to diversify the portfolio.
All of which leads me to believe that the equity premium is finally being eaten away at. Though people have made this prediction before and make it each time there’s a bull market in equities, in this case one can see some of the micro-economics of arbitraging away some of the premium with the development of new kinds of assets or the higher valuation of bond like, low volatility assets.
Of course these burgeoning asset classes are not perfect substitutes for bonds, but they’re better substitutes than equity! Now if the debt equity premium falls one would expect that to occur not just by the increased demand and higher prices for equity, property and quasi-equity and property like assets, but also by reduced demand for bonds, lowering their price and increasing their yields (ie interest rates).
So I’ll add that to the adjustments that our economy might have to make if some of the things that have gone right for us in the extraordinary run of luck we’ve had since the Asian crisis start unwinding. The good luck turned to bad scenario involves commodity prices falling and interest rates rising as the Asians pull back from funding external borrowing of (mostly) the Anglosphere. But add to that a longer term fall in demand for government bonds as the Macquarie Bank and other financial innovators around the globe succeed in intensifying competition with bonds in the world’s financial portfolios.
On the other hand, we’ve been expanding borrowing to invest in these burgeoning new classes of assets. So while increased interest rates might be difficult for us to digest at some stage, borrowing to invest in assets with higher returns makes sense if we can bear the risk and if we’re doing it well.
Who knows if Macquarie et al are as smart as they look or just leaders in the next fad and will over-reach themselves. If it turns out to be the latter, as Kimmy might say to Kath and Sharon, “you can’t make an omelette without getting egg on your face.”