Real assets with pricing power will beat inflation’s margin drag

Ashton Reid

Recent earnings season revealed a shift in the business community’s thinking about inflation, with many company executives now expecting the rate of growth in inflation to accelerate through the rest of the year. Investors need to adjust their thinking in response to this development, says Martin Currie Australia, part of the Franklin Templeton Group.

Ashton Reid, portfolio manager of the Martin Currie Real Income Fund, says many of the real asset companies have emphasised the growing impact of inflation across their supply chains and their labour forces. Those that have not yet seen a direct impact are reporting clear expectations of an acceleration through the year.

For investors, a tightening of monetary policy in response to accelerating inflation would see an increase in bond yields and, generally, downward pressure on equity values. This is because companies will likely experience increases in costs, which can put pressure on profit margins.

Reid says: “It is a challenging landscape, but we believe real assets provide a compelling inflation-protected investment opportunity, as well as meaningful income upside potential.”

He says the Martin Currie Real Income Fund has been positioned to benefit from rising inflation since early in 2021.

“We have been focused on owning real assets with inflation protection mechanisms and strong pricing power that should exhibit meaningful cashflow growth as inflation rises.”

Shopping centers, toll roads and regulated utilities can benefit from inflation pass-through mechanisms. Many have rents, tolls or charges linked to the Consumer Price Index (CPI) or have rents that are closely correlated to tenants’ sales. They will see higher cashflows as prices rise and revenues are boosted.

Reid says: “A company with strong pricing power will be able to pass costs through to consumers, allowing them to control their margins. What investors must determine is to what extent consumer demand will be affected by companies passing on costs in an inflationary environment.”

One of the Real Income Fund’s biggest holdings is toll road operator Transurban. Its tolling mechanisms are mostly linked to Australian and US CPI. “Our view is that Transurban’s higher toll prices remain affordable in the context of inflation-driven rice increases. People are more likely to pay higher tolls than spend longer on crowded un-tolled roads,” Reid says.

Some real estate segments, such as retail, can provide solid inflation protection. Another of the Fund’s larger holdings is regional and super-regional shopping center operator Scentre Group.

As COVID restrictions have eased, Scentre has seen foot traffic and tenant sales recover quickly. Strong tenant occupancy trends translate into the power to push up rents as tenant sales grow. The company’s recent results demonstrated a strong ability to maintain yields.

Reid says: “One of the key portfolio positioning decisions we have made is to reduce our exposure to less-inflation protected CBD-based office assets, in favour of everyday needs assets. We reduced our exposure to stocks such as Mirvac Group and Dexus Group and increased our exposure to Charter Hall Social Infrastructure and toll road company Atlas Arteria.”

The Fund returned 21.7% (net) over the 12 months to the end of February. Past performance is not an indicator of future performance.

Highlights – Martin Currie Real Income Fund:

• Investment Objective: The Fund aims to provide a pre-tax income yield above the S&P/ASX 200 Index yield and to grow this income above the rate of inflation.
• Invests in Australian listed companies owning real assets (such as property, utility and infrastructures securities) that deliver strong dividend income from reliable revenue streams.
• Targets income growth that exceeds the rise in the cost of living by owning securities that can grow revenue and profit over time.
• Total Assets under management: $976.71 Million (as of 31/03/22).