Why you should consider investing in real assets
With global inflation starting to pick up, real assets like infrastructure and property provide investors with interesting alternatives. These assets are more prone to survive the effects of rising inflation and the tightening of the stimulus reigns by the world’s central banks. The ability to own these types of real assets, which are often hard to come by, is worthy of consideration in the current environment – as Mark Twain said: “buy land, they’re not making it anymore”.
Right now, real assets (as a global aggregate) are at their cheapest prices – relative to financial assets such as stocks and bonds – since 19261. This suggests their potential for relative outperformance. Further, market expectations for additional US Federal Reserve (Fed) rate rises in 2017 have increased, and given real asset relative performance in the US has had an 82 per cent correlation to Fed funds rate since 19502, this presents a case to hold real assets in a rising rate environment. Lastly, a predicted investment boom in US infrastructure on the back of Donald Trump’s election promise to focus spending in that sector may also support this view.
Consider infrastructure if you’re looking for defensive characteristics and long-term cash flows
When you invest in infrastructure, you become a part-owner of the utilities and facilities that provide essential services and help drive economic growth. Your investment is directly contributing to the provision of utilities such as electricity or sewerage, transport (think rail or airports) and community facilities like hospitals.
Infrastructure investments typically provide investors with certainty through exposure to assets that boast long lifespans, low ongoing operational costs and secure contracts that often include inflation-linked pricing. As part of a diversified portfolio, infrastructure can provide many benefits; from lower volatility to defensive characteristics emanating from the provision of essential services and inflation protection given the nature of the underlying contracts.
Established toll roads provide a good example of this in practice. Once constructed, they tend to have very stable cash flows because the number of cars travelling is relatively steady, creating predictable earnings for the company and therefore lower volatility. Even in troubling financial times (like a recession), people are likely to continue driving to work, so they also have defensive characteristics. In terms of inflation protection, toll roads are typically allowed to increase tolls by the higher of inflation or a fixed percentage each quarter.
Investigate property investments beyond our borders and beyond the traditional
Most investment portfolios include exposure to Australian residential property – a sector long favoured by domestic investors. And while it has performed well in recent years, valuations are stretched in several areas and, in our view, many investors are too heavily weighted to domestic property, either directly through their own home and investment properties, or indirectly through bank shares or the broader sharemarket.
Australian commercial property can provide a smart and conservative diversification opportunity, in particular, neighbourhood shopping centres (that offer defensive cash flows if focused on non-discretionary stores such as supermarkets) and select office buildings in growing markets. The Sydney commercial property market is buoyant with offshore investors driving demand and, as we see it, the only major risk is vacancy.
Also, consider diversifying your property interests through the inclusion of exposure to alternative residential property markets such as available in the US. There you’ll be part of the world’s biggest economy and real assets with some favourable long-term dynamics – specifically low borrowing costs, strong rental yields and robust tenant demand with significantly greater market depth.
Working with a unitised property fund (where unit holders share a portion of several properties) may minimise the risks associated with investing directly in single properties.
What about the falling value of listed property and infrastructure assets due to higher interest rates?
These entities had been trading at a significant premium to the actual value of their assets and despite the recent correction, some are still trading at valuations higher than the rest of the market. Investors are concerned that these entities will underperform as rates rise and their interest costs increase; however it is important to remember that in a lot of cases, revenues are linked to inflation, which provides an offset to rising costs.
Akin to Mark Twain’s belief, we feel the ability to own real assets, specifically when the asset type is hard to come by, makes for an invaluable investment case in the current investment landscape. So notwithstanding recent volatility, if you have a longer-term view of investing, we suggest considering globally-listed infrastructure and Australian commercial and US property.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.