Posted on 22 November 2021
Why Real Assets Are the New Black
In an era of low interest rates, asset owners are upping allocations in real assets, prizing their reliable income streams, inflation-proofing, and sustainability attractions. Yet real estate, infrastructure, and natural resources all bring unique challenges that need to be managed, according to Alter Domus’ Anita Lyse, Group Sector Head, Real Assets, and Angela Summonte, Global Head of Asset Owners.
Moving from the Periphery to the Core Portfolios
When Yale University’s endowment fund published its asset allocation for 20201, real assets represented a high 12.5% of the portfolio. In the eyes of many, this represents best practice as the Ivy League research university’s USD $31.2 billion fund2 has pioneered the trend of diversification into non-traditional assets over the past 30 years, resulting in what it terms: “significantly higher expected returns and lower volatility.”
In 1985, nearly three quarters of the endowment was committed to US stocks, bonds, and cash. Today, they account for less than one tenth of the portfolio, with foreign equity, private equity, absolute return strategies and real assets accounting for over nine tenths.
The Yale endowment’s successful shift into alternatives, including real assets, is renowned: it has returned 12.4% a year over the last 30 years3. Increasingly, its example is being followed by asset owners of all types and sizes, seeking similar return and diversification benefits. Despite the pandemic, interest in real assets including real estate, infrastructure, natural resources and farmland is rising.
Take infrastructure, for instance. Infrastructure funds raised about USD $75.5 billion in fresh capital in the first eight months of 2021, compared with USD $105.9 billion for all of 2020, according to data provider Preqin. Investors are hopeful that a post-pandemic boom led by President Biden’s USD $1.2 trillion infrastructure package will drive significant opportunities to co-invest in public-private partnerships across a wide range of markets and asset types.
While asset owners previously viewed real assets as niche investments, that has changed with even smaller institutional investors moving real assets to the core of portfolios in order to reduce risk and raise returns, according to Angela Summonte, Alter Domus’ Global Head of Asset Owners. “Just yesterday I was talking to a small foundation with a €500 million portfolio who is looking at investing more than 12% in real assets,” she says.
From the Illiquidity Premium to Stability
In an era of low interest rates, real assets can provide both a reliable, attractive income stream and a hedge against inflation. They also offer an illiquidity premium, which has historically translated into higher returns than liquid assets. As some long-term asset owners do not need the liquidity offered by fixed income securities, they are naturally looking to increase allocations in real assets.
During the volatility of the pandemic, the stability of real assets also came into its own. “Both from a risk and return perspective, you’re not facing the same challenges as you do in – sometimes irrationally – fluctuating public markets, where you can get your fingers burnt quite easily,” notes Anita Lyse, Group Sector Head, Real Assets at Alter Domus. “Real assets are a lot more stable. For centuries, affluent people have been putting their money into tangible assets like real estate precisely because it’s stable and secure.”
Net-Zero Carbon Benefits
Real assets are also at the centre of the drive for a net-zero carbon global economy. President Biden’s infrastructure package, for instance, proposes funding more clean energy, as well as high-voltage power lines that will deliver this across the US. It aims to electrify public transportation and building networks of car chargers. There is a clear funding gap, though, as a public funding shortfall appears likely to need supplementary private funding.
Beyond infrastructure, real estate, agricultural land and natural resources all have an important role to play in decarbonisation. Take real estate: building CO2 emissions need to halve by 2030 to get on track for a net-zero building stock by 2050, according to the UN Environment Programme4. And turning to the social side of sustainable investing, social housing is a popular area for investment.
As private market investments, real assets can also enable asset owners and managers to influence change. “As the ESG revolution gets under way, infrastructure and real estate offer a straightforward way to show engagement,” explains Summonte. “Impact investors can demonstrate their commitment and impact through real assets.”
“There’s increasing interest in investment strategies that include clear sustainability and ESG elements such as renewable energy, sustainable agriculture and forestry, green buildings and affordable housing, and the pandemic has accelerated that trend,” explains Lyse. “But also, and more generally speaking, we have started to see standards come to the market that will allow managers and asset owners to benchmark and compare between different types of products.”
Illustrating how real assets are embracing sustainability, the GRESB organisation that benchmarks real estate and infrastructure assets’ ESG performance has experienced substantial growth in demand for its ratings in the past year. Participation in its GRESB assessments has grown by 26% to 2,221 real estate and infrastructure entities, covering more than USD $6.4 trillion in assets, despite the travails of the pandemic.
In fact, GRESB’s data is now used by 140 institutional investors – with more than USD $47 trillion in assets under management – to better understand and benchmark the performance of their portfolios.
What are the Challenges?
The illiquid nature of real assets can be a drawback for investors. A toll road or office block is not as easy to sell as a heavily traded equity. But infrastructure and real estate funds have been introducing measures to mitigate this problem to a degree.
Some real estate funds have pockets of liquid assets such as real estate securities. And ‘evergreen’ real estate funds provide a degree of liquidity through quarterly income distributions to investors.
“There have been a lot of initiatives over the past decade or so,” reports Lyse. “How can you create some level of liquidity for investors that need it? You see an increasing number of open-ended funds, or semi open-ended funds, where investors are allowed to redeem under certain conditions and at a certain frequency.”
Another defining challenge for asset owners investing in real assets – whether directly or through funds – is receiving data that provides transparency into the underlying buildings, solar parks, or even farms. These assets are, by nature, opaque.
Says Lyse: “How can you produce investor-level consistent reporting across the entire portfolio, which spans multiple jurisdictions, currencies, accounting standards and so on? That is one of the big, big challenges for asset and fund managers. Equally, how do investors make sure that the asset manager is well-equipped to manage this in the most efficient way possible?”
It will be some time before these questions are answered, but asset servicing organisations are equipping themselves with technology to help. “I think as an asset servicing provider, it’s our job to bring some perspective to a very complex world because we are in the position to collect the information,” asserts Summonte. “We aim to give the client the comfort to access very sophisticated types of assets.”
The fact is that real assets’ attractions and challenges are two sides of the same coin. As these physical assets move to the centre of portfolios, proactive asset servicing providers are investing to improve transparency. But the challenges of illiquidity and opacity can only be mitigated to a degree – and asset owners will likely view them as a price worth paying for steady cashflows, inflation hedging, diversification, and an illiquidity premium.
1 The Yale Investments Office 2020.
2 As at June 30, 2020.
3 The Yale Investments Office 2020. As at June 30, 2020.
4 Building sector emissions hit record high, but low-carbon pandemic recovery can help sector. December 16, 2020. https://www.unep.org/news-and-stories/press-release/building-sector-emissions-hit-record-high-low-carbon-pandemic
This article was originally published in Sensus Magazine. Click the image on the right to flip through our most recent issue or browse through our previous editions of the magazine.
Global Head of Asset Owners
Global Sector Head, Real Assets