A traditional 60/40 portfolio of stocks and bond was hit by a disastrous double whammy: equity markets are suffering from tremendous economic uncertainty in the face of lingering supply chain issues, shifting demand and a tightening financial environment.
At the same time, fixed income investments – seemingly risk-free assets to offset stocks’ volatility – grapple with the reversal of an unprecedented run of dovish central bank policy that has lasted more than a decade. Other safe havens such as gold rallied during the initial stages of the war but plummeted almost 10%1 in the year to date as a result of a stronger dollar and the rising attractiveness of interest-bearing assets. Modern alternatives such as Bitcoin, once heralded as a decentralised inflation hedge independent from the grapples of institutionalised finance, lost 70%2 of its value since its peak in November last year. Beside strong stomachs, investors would come to rely on two pillars in 2022: prudent positioning and maximum diversification.
Beside strong stomachs, investors would come to rely on two pillars in 2022: prudent positioning and maximum diversification.
Unlike most financial assets, the value of real assets is largely defined by their inherent physical worth. The most basic example is real estate: a brick-and-mortar asset, generating a steady cash flow through the rent charged to its occupier. This concept is not new. The first publicly traded Real Estate Investment Trust (REIT) was listed in 1965, and the scope and size of the sector has grown exponentially since.
Today’s real assets landscape allows for a much more diversified approach: in addition to basic residential or commercial real estate, investors can take advantage of attractive opportunities in infrastructure, such as toll roads and bridges, trainlines, electricity generation, energy storage and efficiency, smart grids, waste-to-energy and digital infrastructure; or specialist property assets including hospitals, schools, government buildings, supermarkets, correctional facilities, affordable housing, care homes and e-commerce and logistics warehouses.
While the value of real assets is not decoupled from financial market movements, their risk profiles tend to be markedly different from those of other risk assets such as equities, offering attractive diversification benefits. Consider the Kicking Horse Canyon project, a 16-mile stretch of highway including a 440-yard bridge extending through the Rocky Mountains between British Columbia and Alberta. The route has been developed and is owned by BBGI Global Infrastructure, who, for its operation and maintenance, are paid by the Province of British Columbia.
Unlike most financial assets, the value of real assets is largely defined by their inherent physical worth.
Crucially, the payments are availability rather than usage-based: BBGI get paid as long as the route is operational rather than by the number of cars using it, thus cash flows will not be impacted by a lack of road-trippers discouraged by $5/gallon gasoline prices. Indeed, cash flows for many real assets are often contractually stipulated far into the future, and hence are not as sensitive to short-term economic factors in the same way as equities. Indeed, the beta of such investments – a measure of correlation of returns with those of global stock markets – averages circa 50%3.
This reduction in cash flow risk also allows asset managers to take longer-term views and provides them with sufficient planning security to pay out large proportions of cash flows to investors once projects are up and running. Digital 9 Infrastructure, for instance, has recently committed £50m in funding to expand its subsidiary’s 15,000km network of subsea fibre systems, facilitating communication infrastructure between New York, Dublin, London and beyond. Once established, such cable systems typically have a lifespan of up to 25 years, allowing the manager to plan for the long term and sustainably target an annual dividend of 6p – equivalent to a yield to 5.3%4, compared to the FTSE All-Share Index’s of circa 4%5.
This enables real asset managers to generate steady returns through attractive yields and greatly reduces swings in the capital value of the investment. As a result, returns of real assets run at a significantly reduced level of volatility compared to equities: over the past three years and thus including the peak of Pandemic uncertainty, the simulated volatility of a diversified portfolio of infrastructure and specialist property assets averaged 10.8% (measured by its annualised standard deviation of returns), compared to 18.5% for the MSCI All County World Equity Index6.
Like many other long-term economic contracts, many agreements for the usage of real assets include inflation clauses, adjusting cash flows throughout the life of the asset. This inflation link is of course not perfect, though together with a reduced correlation to consumer demand, which is often impacted by aggressive price pressures, makes real assets attractive investments in inflationary environments.
1-3 Sources: Bloomberg, 4 Source: Triple Point, 5-6 Sources: Bloomberg
Naturally, investing in real assets does come with its own challenges, first and foremost liquidity. Despite the views, one does not simply advertise a piece of Rocky Mountain highway complete with 440-yard bridge for sale and expect it to sell within the day like a share of a FTSE 100 company. Open-ended REITS traditionally employ “gates”: contractual measures to prevent excessive outflows of investor funds in times of market distress when managers would not be able to liquidate their holdings fast enough to meet redemptions.
In the UK, investment trusts offer a more efficient approach: as a close-ended structure, fund managers are able to invest capital for the long term without having to create and redeem shares; and investors trade shares of the overall trust structure on regulated exchanges much like regular equities. As prices are determined by the market, units may trade at a discount or premium to their underlying Net Asset Value (NAV), and thus are still subject to market movements and drawdowns. At Kleinwort Hambros, we are able to take advantage of specialist inhouse expertise, oversight and liquidity management capabilities to gain exposure to these assets in a new pooled investment vehicle: Moorea Real Assets Fund.
Real assets such as infrastructure and specialist property derive their value from their merits to society. Bridges, smart grids, hospitals, and logistics warehouses are fundamental to modern everyday life, and as such are still sensitive to long-term economic and societal change and varying consumer demand.
However, during this time of ongoing uncertainty and marked slowdown in global economic growth, we believe real assets to be a valuable diversifying investment for the same reasons that we rely on them in real life: Steadfast, feasible pillars whose utility is less affected by short-term economic or societal upheaval.
We expect the Real Assets Fund to deliver sustainable returns over time at acceptable levels of liquidity with sufficient diversification in the underlying assets and provide an attractive opportunity for further diversification during the ongoing times of heightened volatility.
Bridges, smart grids, hospitals, and logistics warehouses are fundamental to modern everyday life, and as such are still sensitive to long-term economic and societal change and varying consumer demand.
In addition - and more topical than ever - many assets feature a reasonable sensitivity to inflation.
