At the start of 2022, government bond yields moved higher as monetary policies in developed markets started to tighten to address inflationary pressures. The US Federal Reserve said it would tighten its policy “methodically” and start “to reduce the balance sheet at a rapid pace“.
These comments added fuel to a bond rout that had already driven Treasuries to the worst losses in decades this year, while Russia’s invasion of Ukraine and the scale of the resulting sanctions and increases in energy costs, has the potential to derail the emerging economic recovery as the world exits from Covid-19 restrictions.
Against this volatile backdrop and the dwindling appeal of bonds, we are looking to alternatives, namely renewables, asset financing and music streaming, as potential sources of return.
On the renewables side, battery storage companies that help with the transition to renewable power, have seen strong upgrades in revenue generation and can gain additional revenues from providing capacity availability to the grid.
Furthermore, renewable energy companies in general have contributed strongly in the high-power price environment following Russia’s invasion of Ukraine.
Power prices remain elevated, and we expect long-term power price assumptions will have to rise as Europe tries to reduce its power dependency away from Russia. This should benefit many of the renewable companies’ valuations.
Elsewhere, we like the asset financing sphere where ship and aircraft leasing companies have benefited from escalating transport costs and a recovery in travel from the pandemic.
The costs to hire a ship for a day are increasing due to supply constraints, exacerbated by Russian ships not being able to port in western countries following Russia’s invasion of Ukraine.
There is also a lack of certain types of ships being built over the last decade, and there is a shortage of shipping capacity, particularly in the smaller and mid-size ships that transport cargo to smaller ports that don’t have the ability for large vessels to dock.
Our holdings in aviation are benefitting as airlines get the Airbus A380s back off the ground and issue positive commentary about continuing to use the aircraft in the long term.
These types of assets do not have inflation-linked revenues like renewables or infrastructure, but in many cases their secondary market values are rising on the back of higher commodities, energy, and labour costs. In addition, companies are considering the overall costs of running older assets longer versus replacing them with new ships or aircraft.
We also like music streaming for its investment potential. While the Covid-19 pandemic largely decimated the live music and entertainment scene, recorded music revenues hit an estimated US$12bn in 2020, with streaming accounting for a reported 83%.
Streaming services can, however, be deemed controversial when considering the top 1% of artists account for 80% of all streams, according to a UK Intellectual Property Office report. Other data suggests some artists can receive as little as 2% of the royalties from streaming.
But we are optimistic that record companies, streaming platforms and recording artists can reach a more equitable agreement over royalties and ownership. For one, the UK government appears to have concluded there should be a fairer split of streaming royalties.
The shift towards a subscription-based streaming model has transformed the economics of the music industry, enhancing the visibility of revenues and allowing for significant margin expansion through lower distribution costs and operating leverage, while gaming, social media, and emerging-market growth, increase addressable markets.
Indeed, we believe people paying for music via streaming platforms represents a significant growth opportunity, particularly among audiences in emerging markets such as China, India, Africa, and South America.
Another strength of investment in music royalties is that it is relatively uncorrelated with the economic cycle. The near-universal appeal of music and its importance throughout our lives also gives its commercial strength real longevity.
Geopolitical tensions could continue to cast a cloud over financial markets in the short term, with the threat of military escalations creating an uncertain investment backdrop, but also resulting in rising interest rates on the back of higher inflation.
This suggests a more attractive backdrop for bond investing – at least in nominal terms – but given the current uncertainty around growing levels of inflation, we continue to favour real assets. As ever, we remain focused on our thematic and fundamental stock-selection approach, an approach we believe will serve the strategy well over the longer term.
Paul Flood is portfolio manager of the BNY Mellon Multi-Asset Income and BNY Mellon Multi-Asset Diversified Return funds.
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