Real Assets is an investment asset class that covers investment in physical assets such as real estate, energy, and infrastructure.Real Assets have an inherent physical worth.
Real assets differ from financial assets in that financial assets. In financail assets they get their value from a contractual right and are typically intangible.
At Finance Innovations, our dedicated Real Assets team of industry and sector specialists deliver global reach, with deep local expertise, are deeply embedded in their operating industries by sector and geography and have develoed strong partnership networks over time.
Source: Finance Innovations, as of October 31 2019
We enter 2020 with a base case of moderate economic growth but a watchful eye on geopolitical risk. Absent any major shocks, we believe three key themes will drive the industry narrative this year: a long and slow cycle, strong relative value and movement towards a future shaped by powerful structural trends including demographics, sustainability, technology and policy.
With a different sort of cycle, strategies need to adapt.
Seek to benefit from global dispersion
Dig deeper on issues of Sustainability and technological change.
The recent slow down in the global economy had only a moderate impact on Real Assets market activity. In real estate, occupier demand remains strong where vacancy rates have fallen over the past 12 months and are significantly below their long-term average on most global markets.
Moderate global economic growth for the foreseeable future has set in and appears to be the new normal. At same time, usual late cycle limits, most notably an overheating in factors such as wage and price inflation that would pprompt central banks to tighten even as recession risks rise, are not visible. On the contrary, interest rates fell during the year. As a result, we believe we are in a slow-moving cycle or to say it differently: even lower for even longer.
In this environment of moderate growth and low rates, Real Assests fundamentals remain sound (as discussed in the prevvious section). New construction remain in check in a vast majority of global real estate and infrastructure markets, with a combination of disciplined lending markets and structural barriers such as higher construction cost and policy uncertainties. As a result of this relative demand-supply balance, and in line with the last few years, income growth has drivwn healthy and stable Real Asssets returns.
While from a high level, the market may appear similar to 2019, there are divergence acccross both sectors and markets(more on that in the next theme). Even though we have experienced an unsually long and stable cycle, cycles are not dead; rather, they are stretched and bumpier. In such a market it is important to remain cognizantof any emerging imbalances. Patience, risk control and flexibility remain critical.
We are also seeing cracks emerging in the publicly-listed and debt markets. Within listed strategies, there is an increasing polarization. Strong management teams with higher quality assets and better capitalized businesses are outperforming while weaker management teams and businesses are struggling. Within the debt space, yields have tightened for deals, there are some signs of stretching on underwriting assumptions. However, in Europe, only the largest sponsors are able to secure covenant-light structures.
Risk-adjusted returns from Real Assets remain attractive relative to other asset classes amidst the stable "lower for longer" interest rate environment and a backup of negative policy rates in several of the world's major economies.
Forward return expectations across aasets classes are moderating as detailed in our capital market assumption. This has compelled investors to reconsider their asset class allocation in favor of income producing Real Assets.
Investors are increasingly shifting allocation to the Real Assets sector and entry yields offer favorable relative spreads to risk-free rates.
Although we had expected yield compression (or multiple expansion) to come to an end last year, the movemnet lower in interest rates and increased Central Bank accomodation accross the globe has us more convinced that moderate valuation gains are still possible in some markets. However, while we remain positive on valuations given the market backdrop, we must recognize that asymmetric risk is rising. With prices tight, the likelihood of a shock to the downside outweighs the likelihood of significant moves higher. The tighter market relationship to binary outcomes such as future Central Bank rate decisions, geopolitical trade issues and policy developments mean investors need to be more aware of their risk exposure.
Even in the bounds of a single Real Assets sector we see dispersion. The global renewable power market for example offers investors a variety of potential financial outcomes, with divergence in contracted revenues, size of opportunity and supply of capital all influencing returns. Demands is very tight for long contracted revenues, particularly in OECD countries. This is leading some participants to reach into more opportunistic assets as well as into emerging asstes classes. We see the same characteristics with natural gas and oil infrastructure investments, showing the strong appetite for core stabilized assets.
In Real Estate we see dispersion across sectors and cities. From a sector perspective, industrial properties are outperforming across regions while returns on retail properties remain muted. Meanwhile, across cities we are seeing outperformance in global secondary cities benefiting from tech and professional business service employement gains. In the box below, we discuss how this creates relative value opportunities
Real Assets serve as the building blocks of a changing world. Impacted by changes as technological advances accelerate, urbanization continues, environmental, social and governance (ESG) concerns intensify and global population grows and ages, albeit the rate of growth is slowing (projected to to reach almost 10 billion by 20250 from 8 billion today). These transformative trends are driving society's increasing demand for Real Assets but also changing the nature of this demand, in turn influencing the relative attractiveness of sectors within the asset class.
Furthermore, these drivers are supporting the increasing investment demand for the investment asset class as demographic trends are increassing in pension savings, and retirement rates drive demand for income producing assets
Within infrastructure, we see investable theme around the global energy and power transition, the public financing gap, the rise of digital infrastructure and the investment implicatiion of smarter and more densified cites. Cureently, the global power and energy transition is driving deal flow. The public financing gap remain but associated attempts to invigorate public private partnership models remain challenged. At the same time opportunities are opening in digital infrastructure in the context of smart cities.
Within Real Estate, emerging sectors are increasingly in favor, as exemplified in the living and healthcare spectrumbacked by resilient demographic and urbanizaion trends. Capital invested into these sectors is at record levels. These sectorstend to be more operationally intensive, changing the risk profile for investors. Traditional sectors, meanwhile, are evolving amid developments such as the rise of flexible office providers and continued e-commerce pressures.
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