With interest rates falling, is now the time to consider real assets for income? Craig Keary writes.
Whether its roads, airports, shopping centres, offices, or low-omission electricity generation, real asset investments can add stable long-term returns to any portfolio. Investing in real assets, such as infrastructure and property, has long been a favourite of institutional investors.
However in recent times retail investors are starting to realise the benefits of these asset classes. That is, that investing in real assets can help to broaden your portfolio and capture new opportunities.
In addition, real assets have a lower correlation and volatility compared with traditional asset classes and can bridge the gap between fixed income and equity.
Retail investors can gain exposure to infrastructure and property by investing in funds that have direct infrastructure or property holdings or those that have exposure to these assets via listed entities.
Some of the benefits of these assets include the potential for:
- Consistent high yield income;
- Capital stability;
- Inflation protection;
- Diversification; and
- Capital growth.
The appeal of real assets is the greater sense of security that comes from an asset that has tangible value.
This tangible nature makes them easier, particularly for retail investors to relate to, especially once real assets and their benefits are better understood.
Infrastructure
Today there are more infrastructure investment opportunities than ever. As governments worldwide find it increasingly difficult to pay for essential infrastructure, the private sector is stepping in to build, own and operate these facilities.
The demand for infrastructure is also being driven by activity in developing nations due to increasing urbanisation and the need for upgrading ageing infrastructure. To keep pace with anticipated global growth, the world needs to spend an estimated US$57 trillion on infrastructure by 2030.
Infrastructure can be broken into two main categories, economic and social:
Economic – includes facilities and services such as toll roads, airports, communication systems and power and water distribution
Social – includes hospitals, schools, affordable housing and correctional facilities.
Infrastructure’s key benefits are:
- Predictable income – typically, infrastructure assets have long-term contracts (30-40 years) to operate a facility, thus providing predictable income;
- Monopolies – infrastructure businesses often have monopolistic characteristics because of high start-up costs or government regulation, which protects them from entry by competitors; and
- Built-in consumer demand – due to the fact that infrastructure assets provide essential services, demand for these assets tends to be stable. This makes infrastructure a defensive asset class which is a valuable tool to have in a balanced portfolio.
Property
Property is a large and diverse asset class that includes a broad range of sub-sectors; however for retail investors there are four key types – commercial (office buildings), retail, industrial and residential.
Property is often a long-term investment, offering investors the potential for efficient risk-adjusted returns.
These returns can be generated from rental income and movements in the value of the property, or capital growth.
Direct and unlisted property can both play an important part in an investment portfolio and offers diversification benefits, as unlisted assets perform well at different times to listed assets, helping to smooth returns.
Property’s key benefits are:
Regular income – individual properties often have long-term contracts in place with renters which are linked to inflation and generate predictable rental yields.
Access to new opportunities – investing in a property fund provides access to a range of global property sectors that are generally very difficult to access directly.
Expertise – commercial and industrial properties are managed by specialists with expertise in securing quality long-term tenants to maximise rental income, as well as how properties can be improved to generate the maximum revenue for investors.
What are the large institutions doing?
In a recent survey by AMP Capital and Institutional Investor magazine, 60 of the world’s leading institutional investors were surveyed on asset allocation and investment trends.
The findings showed that direct infrastructure assets were the most popular asset class to invest in during the first quarter of 2013. This was followed by private equity and listed real estate.
A survey conducted by Pension & Investment (P&I) magazine identified that 46 per cent of respondents plan to increase their asset allocation to real assets in the next three to five years.
The attraction of real assets is the class’s risk-protection characteristics coupled with the potential for higher returns.
The P&I survey also found 24 per cent of institutions invested in real assets to decrease their portfolio’s risk profile, while 12 per cent invested in this asset class to increase their return profile.
Infrastructure and property – both yield and capital growth
Besides the traditional asset classes of fixed income and equities, Figure 1 also highlights how real assets, such as direct infrastructure and direct commercial property, have in recent times provided high comparative returns.
Investors are increasingly recognising that infrastructure and some property assets can potentially provide higher returns as well as capital stability for comparatively little additional risk.
Real assets are considered to be a step up the risk-return curve from cash and fixed income – without having to take on the risk associated with equities, as shown Figure 2.
A different conversation with clients
As term deposit rates continue to fall, investors are seeking alternate sources of income so it is worth considering real assets for a client’s portfolio. As real assets are tangible, they are easier to understand and are a realistic solution for investors seeking consistent income and capital preservation.
Also, for those who are still fearful of the risk involved in higher risk asset classes – such as equities – the real asset class should be contemplated for its lower correlation and volatility to other asset classes.
The catch-phrase that real assets = real returns, is real!
Craig Keary is head of retail at AMP Capital.
