Tangible Durable Moat Stocks as Real Assets

Real assets, especially in inflationary environments, are a useful diversifier for portfolios. This blog explores how Tema Monopolies and Oligopolies ETF (TOLL), a fund investing in durable, tangible and dominant moat equities could act as a real asset.

Key takeaways: 

• TOLL invests in liquid publicly traded infrastructure and infrastructure-like companies, selling mission critical goods and services.
  
  
• These businesses earn inflation linked revenues that are highly recurring and durable.
  
  
• TOLL offers exposure to the quality factor, which tends to do well in inflationary regimes. Quality is a consistent factor for outperformance across market environments.
  
  
• Since inception TOLL has shown good diversifying properties to traditional assets and within real assets.

What is a real asset? 

Real assets are an asset class that covers investments in physical assets, that are grounded and valued in the physical world. Examples of real assets include natural resources, infrastructure, and real estate, often accessed through equities exposed to these sectors. In portfolios, real assets act as a diversifier, due to their low correlation to traditional assets, as well as offering inflation protection.

How is a durable moat stock a real asset?

TOLL invests in liquid publicly traded infrastructure and infrastructure-like equities.

Infrastructure infrastructure-like equities exhibit the key features of a real asset:

• Essential goods and services with inelastic demand
• Recurring and durable revenues
• Inflation-linked revenues

Essential goods and services with inelastic demand

Paying a toll to avoid congestion, swiping a credit card to make a payment, the engine powering a commercial flight, or the credit score on a credit application are all essential goods and services of the modern economy. They involve small every day transactions for which the demand is inelastic i.e. not sensitive to the price paid. TOLL invests in companies that sell essential goods and services:

Recurring revenues

A key characteristic of durable moat firms is a recurring revenue stream. For infrastructure assets this stems from very long (40-50 year) concession contracts. For example, Ferrovial have a 40 year concession on their managed lanes (toll roads) in Texas and New Jersey and has recently acquired a 40 year concession on the new Terminal One at JFK New York Airport. During these concession periods infrastructure firms earn contractual inflation linked revenues, such as the toll or per passenger fee, as well as non-contractual but captive revenue, such as rent on shops in a terminal.

Recurring revenues can also come from a razor/razor blade business model – where selling a razor creates a recurring stream of razor blade revenues. Idexx Labs is the leading provider of veterinary diagnostics machines. Once a machine is placed the consumables form a highly recurring revenue stream meaning 95% of the company’s revenue is recurring. GE Aerospace spends a lot of money and effort designing a jet engine and earns most of its profit on the service and support of these engines which can stretch out for decades. GE’s current generation engine, CFM 56, first went into service in 1974.

The most important aspect of a real asset is having revenues that are linked to inflation. This can be explicit, as in the case of a railroad where pricing is set off railroad inflation. It can also be implicit. Moody’s earns revenue from debt issuance – and debt is a nominal number the higher inflation is the higher the value of debt issuance. The same could be said of Visa that takes a small revenue toll from total personal consumption expenditure, a figure that rises with inflation.

Inflation protection also comes in at the portfolio level. TOLL is most exposed to the quality factor, which tends to do well in inflationary regimes.

Source: Chart - Data from January 1875 to November 2023 except for Quality, which starts in 1940. Due to lack of data in deflationary periods, Quality is left out. Northern Trust Asset Management (link).

Correlation to traditional and other real assets

Real assets serve a diversifying position in a portfolio in that they have lower correlation to traditional assets. Based on data since inception TOLL has a similar correlation to equity markets of established real assets like real estate with a lower correlation to bonds. TOLL also has low correlation to other real assets such as commodities, creating within real asset diversification benefits.Source: Top chart from Orion/Brinker analysis (here). Bottom chart from Bloomberg. TOLL inception 05/10/2023

Bottom line

TOLL has all the features associated with real assets. Infrastructure and infrastructure-like businesses provide essential goods and services and earn recurring inflation-linked revenues. At the portfolio level the quality factor performs well during inflationary periods and TOLL offers a diversifying correlation profile akin to other real assets.