While the world may have suffered its share of challenges and dislocations over the past decade, the aviation sector has continued to move from strength to strength. The increasingly mobile nature of the global economy has seen air travel volume more than double over the past 15 years. 2016 marked the seventh straight year of above-trend growth and 2017 looks set to follow suit. The emergence of millions of new middle class consumers in nations such as China and India—many keen to experience air travel for the first time—is likely to accelerate the trend even further. For instance, it was recently announced that China plans to spend over $1Tn on planes over the next 20 years.
Where there is growth, there is a need for finance to match. The post-crash financial landscape means that companies are less able to rely on bank finance than in days gone by. As such, aviation firms are increasingly innovating when it comes to accessing the money they need. While the sector traditionally relied largely on equity and bank finance, in 2016, 30 percent of all capital for aviation came from alternative sources such as hedge funds and private equity.
This figure is likely to rise. And the private equity sector in particular is keen to get more involved. In recent years, Cinven, CVC, Carlyle, Cerberus Capital and Terra Firma, among others, have invested in a variety of aircraft leasing businesses, and only a few months ago Castlelake closed its third aviation fund at $1Bn. Jetstream Aviation Capital and Apollo Aviation Group are just two PE fund groups specifically focused on the sector.
Historically, aviation finance has not been seen as an obvious investment area for private equity. In the current macroeconomic landscape, however, the appeal is clear. In an otherwise volatile, low-yield macroeconomic landscape, the sector offers GPs an ideal means of diversifying portfolios in a way that is minimally correlated with wider equity and bond markets, while also offering strong, sustainable income—with the added benefit of loans being secured against valuable assets.
Furthermore, it is clear that investor appetite for this sort of alternative investment is also on the rise. Demanding new regulatory requirements have placed considerable pressure on institutions such as insurance companies and pension funds, and they are on the lookout for less liquid investments that offer a higher risk-adjusted return. As well as fitting this bill, aviation finance offers investors a number of additional benefits. For instance, as well as this diversification advantage, aviation is a highly regulated industry, with investor capital often protected. Cash flows are also often secured on physical assets, and unlike property these assets are highly fungible.
Nonetheless, as well as offering opportunity, the idiosyncrasies of the aviation finance sector also present a number of challenges for GPs. Aviation is a differentiated segment, and requires a differentiated approach. Taking a cookie-cutter approach is likely to cause problems, and will prevent GPs and their investors from reaping the full benefit of exposure. There are a wide variety of investment-types available, and each aviation fund has its own structure, with its own nuances. For instance, aviation leasing assets provide current lease income and special tax benefits, unlike a typical "J-curve" investment fund or venture capital return profiles.
For this reason, GPs looking to move into the sector need to consider partnering with a third party that has niche expertise, and is familiar with the unique and complex structures involved. Given the distinctiveness of the industry there is a steep learning curve when it comes to the establishment of relationships, the acquiring of appropriate technical knowledge, and the ability to cover all of the required documentation regarding operating leases, purchase transactions and so on. Reporting, in particular, is a whole different ball-game in aviation finance when compared with more traditional private equity investments—for the uninitiated it can all be overwhelming.
With trends as they are, we could well be looking ahead to a world where over half of aviation finance comes from alternative sources. For GPs that move now, and treat the sector with the specialist attention it deserves, the sky's the limit.
Hugh Stacey is executive director at Augentius.
