Mention the aviation industry today, and the recent tragedies involving two 737 Max aircraft will be part of that conversation. While flying may involve less risk than driving on a statistical basis, safety has once more come into sharp focus.
Safety is of great importance given that expanding world economies and a steady growing global middle class will generate a huge future increase in air travel. It is estimated that the world will need around 40,000 new aircraft during the next 20 years to meet expected demand.
From an investment perspective, aviation will become a reliable proxy for the interconnected global economy of the next 20 years and will present an enormous thematic investment opportunity.
In order to take this opportunity, investors need to understand the distinction between the very different industries involved in sustaining the future demand for flight.
The aviation sector involves three main functions: building aircraft, owning aircraft, and operating aircraft. For investors, the greatest opportunity lies in leasing aircraft to airline operators. There is sustained demand for planes throughout the course of their lifecycle and they can create a bond-like investment with a low correlation factor to traditional asset classes.
However, this is a very specialist sector and it is essential to have investment management expertise which understands not just the structuring of aviation finance but also the technical characteristics of the planes and their maintenance requirements.
The supply of aircraft is relatively inelastic and very predictable as it is a response to demand from airlines which is identified well in advance of when the planes are needed operationally. Planes take a long time to build and there are only two main suppliers: Boeing and Airbus. Even the current grounding of the entire Max fleet does not seem to constrain aircraft supply in the short term, as operators react accordingly. Airlines respond by reducing services, postponing new services and using other aircraft types to fill the void.
In general, the 737 Max can be considered as one of the two most significant passenger aircraft worldwide (the other being the A320 family from Airbus). Boeing will push to solve the current problems satisfactorily as soon as possible. Eventually, the 737 Max fleet will return to service as a reliable and safe aircraft.
However, when tragedy takes place, it affects the supply process. We have already seen the Saudi Arabian budget airline, Flyadeal, cancel a $5.9bn 737 Max order, and others may follow. Airbus looks set to pick up considerable new business as a consequence. But these contrasting fortunes simply serve to illustrate the inherent risk of investing directly in aircraft manufacturers even though they enjoy a virtual monopoly.
In comparison, investing in aircraft themselves locks into the underlying demand for air travel which is more predictable and sustainable over the long-term, and risks can be mitigated by investments in diversified portfolios with various aircraft types and leases with different airlines from all over the world.
Jochen Hörger is managing director of Aviation at KGAL Investment Management