In a world of inflation and supply shocks, real assets make real sense
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In high-inflation environments, real assets offer investors a fighting chance to protect returns, says Vince Childers, senior vice-president and head of real assets multi-strategy at Cohen & Steers in New York.
He said opportunities can be found in real estate, commodity futures, resource equities and infrastructure — asset groups that he describes as the “core four” of real-asset investing.
“I think [they] really are at the nexus of the real-assets opportunity,” he said. “[They demonstrate] a very strong tendency to deliver above-average returns when you’re having inflationary dynamics. Historically [they’re] better than stocks, and certainly bonds.”
According to Childers, commodities and resources are particularly adept at resisting inflation, with infrastructure and real estate somewhat less effective but still ahead of the statistical average of all asset classes.
This quality will prove especially useful if, as he suggested, the global economy heads into a new economic regime marked by negative supply side shocks, downside surprises to growth and upside surprises to inflation. These conditions, he said, will challenge the traditional 60/40 allocation of stocks and bonds.
“The Achilles heel of that allocation, historically, has been these types of stagflationary dynamics,” he explained. “Big parts of 2021 and 2022 demonstrated — I think, painfully to a lot of people — how that type of dynamic can unfold.”
History also suggests real assets “are something you should have in your portfolio on a long-term, permanent, strategic basis,” he said.
Investors need to keep in mind, however, that diversification is key to mitigating risk, he said.
“On a standalone basis, these tend to be very volatile assets,” he said. “So, if you haven’t taken an approach of being diversified, or haven’t been thoughtful about your risk tolerance in these assets, you can end up unwittingly investing in something that has a lot more risk and volatility than it needs to have.”
To balance a portfolio effectively, he suggests sprinkling in some short-duration, floating-rate or inflation-linked bonds.
On the real-estate front, Childers said he favours residential, healthcare and retail opportunities.
“Our biggest underweight is in office, for fundamental reasons that probably aren’t too surprising,” he said. “We worry about the future of a lot of office space, and whether or not fundamentals are fully reflected in current prices.”
As for resource equities, he particularly likes valuation opportunities in the energy, metals and mining, and agribusiness sectors.
Energy, for example, has recently reformed its “grow-at-all-costs mentality” which tended to destroy value and leave disappointed shareholders in its wake.
“That has generated a response in the industry to be more focused on capital returns, capex discipline, and the generation of free cash flow that’s required to make an equity investment make sense over the long term,” he said. “I think the market is still distrustful that this kind of change in mindset and this focus on generating economic value will persist. We are more optimistic about it. We think these valuations make the resource equity universe look particularly attractive right now.”
He acknowledged that listed infrastructure is a hot topic these days, with governments and industries worldwide developing and improving utilities, communications and transportation networks.
“Electric utilities, gas distribution, towers, toll roads, water utilities, freight rails, airports, passenger rails, energy transport, pipelines and the like, all of those things — as differentiated as those assets are — fall under the infrastructure umbrella,” he said. “The growth fundamentals actually look pretty solid to us,” he said.
Childers said commodity markets comprise the basic resources needed for any economy to achieve liftoff. As such, exposure to commodity futures offers “the biggest inflation sensitivity that you can bring into a portfolio.”
They also tend to be the most diversifying elements in the real-assets universe, he said, with the lowest beta to equities and low correlation to fixed-income returns.
“I think there’s always a place in a real-assets portfolio for some kind of commodity futures exposure.”
This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.