The case for a more diversified real asset portfolio is stronger during this late stage of the market cycle, where increased tensions are observed between desired characteristics such as yield and diversification
Many asset managers have recently built and branded Real Assets units, and are now channelling organisational changes towards product development, including the provision of multi-real-asset strategies
These are the key findings of the latest bfinance implementation insight paper, “Rethinking Real Assets”
13 March 2018 – Strong investor appetite for both traditional and niche real assets continues into 2018, with high demand for infrastructure, real estate, agriculture, timberland, renewable energy and more among bfinance’s asset owner clients. While the post-GFC phase was marked by diversification towards real assets, the recent period has seen greater emphasis on diversification within real assets. This has been encouraged by the increasing popularity of more holistic portfolio design, as opposed to segregated asset classes for real estate and other sectors, among asset owners globally.
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As a result, demand for the more niche sectors such as agriculture and timberland has increased substantially during the past three years. Within real estate and infrastructure, what was niche is now mainstream, with infrastructure funds tapping into sectors that would not previously have been included such as energy storage or data centres. In addition, more asset managers are today offering diversified real asset strategies that wrap multiple asset classes into one mandate. The heart of these changes is a mindset that is less focused on labels and prioritises core characteristics, such as inflation sensitivity, diversification from equity and yield. Yet investors should take great care: these characteristics are not hard-wired to real assets. At this late stage in the investment cycle, where increased tensions are observed between target characteristics such as yield and diversification, a diversified real asset portfolio can prove beneficial in theory, but implementation is the critical challenge.
The rise of the real asset portfolio
In recent years, the concept of the ‘real asset,’ tangible asset’ or ‘inflation-sensitive’ portfolio has become increasingly popular within the global asset owner community. Once an approach predominantly used by certain North American and Australian institutional investors, the use of a real assets allocation in portfolio design is now becoming an increasingly widespread global practice, even gaining traction among European and UK pension funds. This trend has been encouraged by the shift towards infrastructure, which can be grouped with real estate to create a bedrock for a portfolio founded on core characteristics rather than labels.
With the late stage of the cycle compressing returns in traditional sectors, tensions are increasing between certain target characteristics such as returns and diversification, and investors creeping towards the value-add end of the spectrum in real estate and infrastructure can become more sensitive to cyclical risks. Diversified real asset portfolios can theoretically outperform in this environment, with recent research demonstrating that they have outperformed standalone infrastructure, real estate or agriculture portfolios at times of low market returns, but only if implemented effectively. Investors and their advisors should remember that the main objective is not to have a resilient real asset portfolio but a resilient total portfolio.
Asset owners are not the only ones shifting towards real asset units. Many asset managers have now established real asset divisions in a bid to take advantage of industry trends. Given the organisational overhauls involved when managers have built, bought or branded these teams, investors should pay close attention to issues such as staff turnover, integration and leadership when evaluating and selecting managers.
Strong investor appetite for niche real assets
The post-global financial crisis (GFC) phase was marked by diversification towards real assets, however later years have seen increased investor appetite for diversification within real assets. bfinance has seen increased demand for agriculture, timberland, renewable energy infrastructure and real asset debt. Attractive traits are available to varying degrees in the different sub-sectors, as illustrated in a detailed table summarising strengths and weaknesses, and so a combination can prove potentially beneficial.
Investors may consider real assets in terms of four quadrants traditionally used for real estate – unlisted and listed, debt and equity. Although some vehemently argue against the inclusion of listed infrastructure and REITS in real asset portfolios (#fakeinfra), bfinance cautions against blanket statements and reminds readers that, while listed real assets can be strongly correlated with equities, certain parts of the unlisted real asset universe are also correlated, while other characteristics should be considered.
Multi real asset strategies
A new theme is currently emerging, wherein increasing numbers of asset managers are developing multi-real-asset capability, delivering several real asset types under one mandate. Diversified real asset mandates may be viewed as the logical next step with both asset owners and asset managers taking a more holistic organisational approach to this sector.
According to manager searches for Diversified Real Asset mandates conducted by bfinance in 2017-18, there are three different structures available for investors to consider, including pooled funds, wrappers of managers’ in-house products and classic fund-of-funds. Each of these structures holds different advantages and disadvantages in terms of cost, alignment of interest and customisation.
Among investors, the single mandate for a range of niche real assets is more popular than the mandate integrating traditional real assets (e.g. real estate and infrastructure), though there is appetite across the spectrum. These mandates have necessitated broad, fresh approaches to the market, with few “off-the-peg” solutions advertised.
Where clients are relatively new to real assets, the team encourages them to start with more traditional property and infrastructure, but with an eye to building potential exposure to other sectors over the long term. For institutions that are highly advanced in their approaches due to a long experience with different genres of real asset investment, including some of the firm’s Australian and Canadian clients, the main priority has been building complementary niche exposures around the traditional strategies. Yet generalisations should always be treated with caution: investors’ needs and expectations from real asset investments vary widely, even for institutions of the same type and size in the same country with an equivalent level of experience.
Peter Hobbs, Managing Director, Private Markets at bfinance, commented: “Today’s investment climate has, in theory, strengthened the case for a more diversified real asset portfolio. The late stage of the cycle has compressed returns in traditional sectors, and also increased the tensions between certain key traits, such as “returns” and “diversification vs. stocks.” With investors creeping towards “value-add” end of the spectrum in infrastructure and real estate, for example, they may also increase sensitivity to cyclical risks. Over the past year, bfinance has observed multiple managers and consultants advocating a diversified real assets approach, for a variety of reasons including product marketing, but many of these arguments overlook the challenges of implementation. It is also critical to remember the main objective: the end investor’s priority should not be to create a resilient real asset bucket but a resilient total portfolio. Diversification is not valuable if its results can be mirrored by adding stocks or bonds to the mix: that’s where inter-asset class diversification should come into play.”
Kathryn Saklatvala, Director of Investment Content at bfinance, commented: “Ten years ago it would have been hard to name a Head of Real Assets at a major asset management firm. Today the role is a common one and the supporting M&A trend continues in force. Meanwhile, integrated real asset portfolios are also increasingly popular among pension funds and other asset owners globally, supporting greater diversification into niche sub-sectors. Yet, with a trend of this magnitude sweeping the industry, the fallout can be complex and challenging. Supposed diversification does not necessarily deliver a more well-diversified portfolio. Supposed real asset investments do not necessarily deliver the desirable characteristics associated with this space. At the end of the day, ‘real assets’ is only a label: what’s inside the tin is what matters.”