In an environment where uncertainty is commonplace, investment in transportation equipment is often driven by residual value estimates as lenders and lessors compete for market share. Many factors influence the future value of equipment. Most are not very predictable. All require an active aftermarket for the asset under consideration. Physical factors include wear and tear and useful life estimates. Technical factors impact value when newer (more efficient) designs appear causing demand factors to change. Regulatory factors occur from time to time as government imposes new requirements. The FAA’s current review of the 737 Max MCAS and safety procedures for earlier 737 models is an example. Additional flight crew training is expected (even on the 737NG models) including emergency procedures, maintenance training, and an evaluation of pilot response times. Macroeconomics, tax regimes, and global trade impact pricing. In both expanding and contracting markets, investors and their advisors track the behavior of sale prices purchased new, when returned from lease and sold into the secondary market, and similarly track lease rates for short, mid, and longer term leases. In these different environments releasing at lease end, prior to sale, adds value and reduces investment risk.

Residual valuation estimates future equipment value by establishing a relationship between the historical price of equipment and the most appropriate relevant factors. It is particularly useful when making long term investment decisions for both aviation or rail assets. Once you identify factor relationships you have access to a wide body of knowledge about basic economic variables such as GDP, interest rates, commodity pricing, and the impact of international politics on global trade. This is important simply because there are more experts with reasoned views on these topics than there are on the future pricing of air and rail assets.

A key component in this process involves estimating correlation between the various factors. Estimates of value are described in terms of a distribution rather than a point estimate. Standard deviation is a measure of risk and variability of returns. The higher the standard deviation, the higher the ‘riskiness’ of an investment. In simple terms, the standard deviation measures how much variance exists around the average. The coefficient of variation is useful in determining which investments have more relative risk when investments have different average returns. The coefficient of variation tells us the probability of experiencing a return close to the ‘average’ return. The higher the coefficient of variation, the riskier an investment per unit of return. Covariance is a measure of how price movements between investments are related to one another. Correlation is a scaled version of covariance that takes on values between -1 and +1. A correlation of +1 denotes that two assets are positively correlated. A correlation of zero denotes that assets are completely uncorrelated. A correlation of -1 denotes a perfectly negative correlation.

Investors are rational. Markets are efficient. Managing portfolio risk in an uncertain environment recognizes values can increase as well as decrease. Your tools should incorporate disciplined analysis combined with optimal use of available information. Uncertainty requires understanding there are factors which cannot be quantified.

Forethought, diligence, statistical analysis, confidence in equipment alternatives. Sound decision making in real time. Looking for Alpha? Call RESIDCO.

The Importance of Infrastructure

Infrastructure is one of the main factors of economic growth. This includes power, water, telecommunications, ports, roads, and rail. In a report by McKinsey Global Institute, the projected requirement for infrastructure investment is estimated to reach $57 trillion dollars from 2013-2030. This is to keep up with global GDP growth targets. According to PWC, globalization enabled free movement and distribution of goods around the world, while travel and people to people linkages enabled the movement of data and currency. Such massive activity is only possible through physical and digital infrastructure. Due to the expected shift in economic and demographic trends, there is an enormous need for boost infrastructure spending.

According to the Business Roundtable, statistics show the need for improvement in America’s infrastructure spending: the infrastructure quality of the U.S. currently ranks at no. 16 globally, behind France, Japan, and Germany. Among the world’s top 50 airports, the U.S. only has 4 included in the list; delays and congestion have amounted to $24 billion losses in 2012 alone. Around 25% of rails around the country is marked as “good” or “excellent.” Clearly, there is a lot of room for improvement. The U.S. economy would greatly benefit from massive infrastructure spending.

An article by the Council of Foreign Relations mentioned the current state of U.S. transportation infrastructure. Many highways and bridges in the U.S. will reach the end of their maximum expected lifespan, thus the need for adequate capital investment in order to conduct major repairs to these infrastructures. The last era where transportation infrastructure has benefited was during former President Eisenhower’s time until the 1980s. Afterward, spending on transportation infrastructure has significantly declined.

Short and Long-term Benefits of Infrastructure Investment

Infrastructure investment can have short-term and long-term economic benefits.  Building and construction efforts will result in a boost in employment; more jobs will be created. Long term gains involve sustained economic growth with greater benefit for the population, with better services and smoother flow of people, goods, and services associated with high-quality transportation, better roads, rail, airports, and seaports, among others.

Admittedly, transportation infrastructure requires a significant amount of capital investment, and traditional government funds may not be enough. This is where the private sector can come in. The Financial Times mentioned that some policy experts advocate for greater private sector involvement in infrastructure investments, mainly through public-private partnerships or PPPs. PPPs are projects done in long-term contracts, with direct cooperation between the public and private sector. Private capital can then fund infrastructure through municipal bonds. Ultimately, there are risks and returns to be considered but this may vary depending on the project involved. As mentioned in the article, a public-private sector partnership may result in lower costs in terms of technological or operational components or expertise, compared to a public sector-led initiative.

The bottom line is that there is a massive need for transportation infrastructure investment in the United States, and there is no better time to invest than now. Investing in transport infrastructure means investing in the future and ensuring long-term economic benefits for the country. This unique opportunity is sustainable and its effects are long lasting. As emphasized in the Business Roundtable report, the following benefits can be obtained with increased investments in the transportation infrastructure:

Increased GDP growth – investment in transportation infrastructure will generate more jobs; the maintenance and repair projects will further boost employment and create jobs that are permanent and well-paying, which can benefit the middle class, resulting in an increase in GDP growth.

Increased productivity – Efficient and modern infrastructure translates to greater productivity by improving safety, reducing labor costs, fuel expenditures, travel time and other unnecessary effects of uncertainty. Supply chains run more smoothly and the cost of doing business is lower.

Increased international competitiveness – High-quality infrastructure will attract foreign direct investments and encourage businesses to expand their operations.

Investing in Transportation Infrastructure

Investment in transportation infrastructure will result in highly sustainable, short- and long-term economic gains.  It is a win-win solution and a unique opportunity that businesses should take advantage of. Infrastructure plays a crucial role in providing employment opportunities, increasing productivity and boosting international competitiveness, and is a proven key factor in driving economic growth. To know more about investing in transportation infrastructure, call or visit RESIDCO for more details.