Inflation, forecast to be transitory by many market observers earlier this year, has proved to be persistent. The possibility of stagflation looms. Both stocks and bonds have suffered. Real assets, defined as tangible assets that have intrinsic value, such as real estate, commodities and infrastructure, and that tend to offer inflation protection, are well poised for this environment, according to asset managers and index providers. Real assets also offer additional benefits, such as diversification and yield, leading many allocators to respond to the call for a long-term strategic allocation to real assets, and not just as a tactical one in response to the short-term spike in inflation.
“Inflation protection and diversification are at the forefront of institutional investor interest in real assets today,” said Jim Wiederhold, associate director of commodities and real assets at S&P Dow Jones Indices. “Real assets such as real estate, commodities and natural resource equities have historically tended to perform well during periods of high inflation and have demonstrated low correlations to major asset classes.”
Real Assets: Meeting the Moment Webinar
This audio webinar takes a deeper dive into real assets segments such as commercial and multi-family real estate, commodities, gold and more, giving investors current insights on opportunities and risks to watch, as well as the latest developments on ESG integration, portfolio monitoring and benchmarking across allocations.
Featuring
Martha S. Peyton, Ph.D., CRE
Managing Director and Global Head Real Assets Research
Aegon Asset Managemen
Michael Orzano, CFA
Senior Director, Global Equity Indices
S&P Dow Jones Indices
Louis Basque, CFA
Portfolio Strategist Investment Solutions Group
State Street Global Advisors
Joseph Cavatoni
Regional CEO
World Gold Council
Wednesday, November 2, 2022
2:00 p.m. ET
Wiederhold noted that commodities represented by the S&P GSCI Index and natural resources represented by the S&P LargeMidCap Commodity and Resources Index have performed better than other asset classes in 2022. “These are the assets with the highest historical inflation betas,” he said. A risk-off environment such as a recessionary or an inflationary environment can still negatively impact real assets, he said, but possibly to a lesser degree than other major asset classes: “This is because they tend to be better stores of value.”
This performance has led investors to realize this may be an opportune year for real assets. “With the macro backdrop of inflation, investors are looking for alternatives” Wiederhold said.
“Inflation has motivated investors, and those that did not have an explicit exposure to inflation-sensitive assets in their portfolios are taking a hard look at real assets,” said Louis Basque, vice president and portfolio strategist at State Street Global Advisors’ Investment Solutions Group.
The reason that investors need real assets today is clearer than it has been in decades. “First and foremost, they are meant to be inflation-sensitive assets. Diversification, compelling risk-adjusted returns and a source of income are added benefits. Other assets don’t bring the inflation-sensitive piece to the puzzle. That’s what’s unique about real assets,” said his colleague, Robert Guiliano, vice president and senior portfolio manager at State Street Global Advisors’ Investment Solutions Group.
“The broad characteristics of this asset class argue for a diversified core allocation that can help meet investors’ risk and return objectives beyond expressing a short-term tactical outlook on inflation. Real assets always belong in a portfolio,” Basque said (see chart on real asset correlation and beta across asset classes).
Basque’s forecast: “The outlook for real assets, and especially commodities, remains firm.” He highlighted the attractiveness of infrastructure, which received a potential boost in the U.S. by the passing of the recent Bipartisan Infrastructure Law and the Inflation Reduction Act of 2022. Other asset classes for investors to consider are real estate, natural resource stocks and Treasury Inflation-Protected Securities, he said.
Investors can select specific real assets based on their own economic forecasts. “Real assets respond to different kinds of [economic] environments depending upon the assets being used,” Guiliano added. “Inflation has probably peaked, but it’s still high, and real assets like commodities, natural resource equities and real estate can make a positive contribution in keeping total portfolio returns elevated,” he said. “If we should move to a stagflation environment, real assets like precious metals and gold, inflation-linked bonds and, to a lesser degree, infrastructure, farmland and timberland can play key roles in supporting a diversified portfolio.”
“We encourage investors to invest in a broad variety of real assets. Our multi-strategy approach focuses on asset allocation using indexed underlying exposures. That’s an effective way to get the benefits of real assets and to provide diversification,” Guiliano said.
“Inflation hedging, yield and diversification have long been the foundation of investor interest in U.S. commercial real estate,” said Martha Peyton, Ph.D., CRE, managing director and global head of real assets research at Aegon Asset Management. “Surveys of investors have mentioned these same factors, usually starting with diversification, but in recent months, inflation hedging has risen in priority.”
With the long investment horizon of commercial real estate, inflation hedging can be approximately measured by comparing returns to inflation over a rolling five-year period, Peyton said. “These metrics show that commercial real estate has been quite a good hedge against inflation over typical investment horizons.”
Beyond that, return considerations have been very attractive. “The performance over recent quarters has been astonishing,” Peyton said. Total return for the National Council of Real Estate Investment Fiduciaries’ NCREIF Property Index for the 12 months ending June 30 this year was 21.5% (see chart). These returns partly reflect GDP growth which led to increased demand throughout the economy, Peyton noted.
A number of sector-specific developments provided strong support for significant returns. “In the industrial sector, e-commerce took off as a result of COVID, accelerating the demand for warehouse space,” she said. These dynamics helped to support the 47.7% total return in the industrial sector for the 12 months ended June 2022.
“In apartments, several tailwinds came together, including the maturation of millennials and the surge in household formation. Supply was too tight to accommodate all the demand,” Peyton said. Total return for apartments was 24.4% for the 12 months ended June 2022.
However, despite the apparent consistency of strong returns in commercial real estate, the outlook for the sector is more muted. “Our expectations for real assets are in line with the Blue Chip [Economic Indicators] survey consensus, which [sees] U.S. GDP growth diminishing to 0.6% in 2023,” Peyton said. “That’s an enormous slowdown, but it is not a recession forecast for the U.S. economy. We expect the Federal Reserve will successfully manage an improvement in inflation. Commercial real estate performance will slow, but it will benefit if the U.S. manages a soft landing.”
Given that a major theme in Aegon AM’s forecast is one of uncertainty in a weakening economic environment, investors also need to carefully monitor specific sector developments. “The apartment sector is searching for an equilibrium by balancing availability, household formation and affordability. In response, investors are coming to the market with more uncertainty about the prices they’re willing to pay for new investments,” Peyton said.
Read: Expanding the ESG Toolkit with the Dow Jones Select ESG Real Estate Securities Indices
“The retail sector is responding to demographic shifts across the U.S. Some metro areas are losing population, while other metro areas are showing very strong population growth,” she said, noting that the Southwest and cities like Austin and Phoenix have strong demographic growth in contrast to the Midwest. “The question marks in demographics are the big coastal cities, like New York and San Francisco,” as their ability to recover from the shock of COVID and to grow again is highly uncertain.
“In the industrial sector, there is accumulating uncertainty about the demand for space,” Peyton said, noting Amazon’s announcement earlier this year that its appetite for more space has diminished significantly. In addition, she noted the office sector faces uncertainty around the return to work. “Forecasters across the board are assuming that COVID will not rear up again and impair growth. But is it really over?” That is the true unknown facing commercial real estate and the economy.
When considering commodities, the World Gold Council has a long-term view on gold and its strategic position in investors’ portfolios. “Gold has a unique nature,” said Joseph Cavatoni, WGC’s chief market strategist for North America. “It’s a commodity and it’s a financial asset. Demand comes from many sources, including consumers, investors, technological [uses] and central banks.”
Inflation protection is just one of the many reasons for investor demand for gold today, Cavatoni said. “As investors look at which risk-mitigating assets could be added to their portfolios,” gold has offered average returns of 11% over the past 50 years and is a deeply liquid market, he said. Gold also provides diversification, as “it correlates positively with equities when they’re on the rise but negatively when they’re on the decline.”
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