Transcript: Stay the course: real assets are built for geopolitical shocks

The primary channels that impact real asset performance

VC: If something is going to hit, we’re going to see it in energy prices. And of course, we already have. That’s where you expect to see it first, with any type of supply shock of this nature. The next thing that will tend to happen is concerns about where do those higher energy costs feed through? So, what comes after oil? Well, gasoline, diesel, natural gas depending on where you are. If it’s Europe, utility prices. And so, you start to look and say, what are the elements that can pass through potentially to core inflation in an enduring shock. But almost always, the first order effect is going to be commodity prices. We’ve done analysis where we’ve looked at numerous drivers of inflation and inflation shock. In pretty much all of those cases, it’s commodity futures that tend to move the first and move the strongest. And then, generally, the resource equities after them, in terms of real assets impact.

Short-term price shocks and longer-term structural shifts

VC: Short term, you get price shock responses that are either reflective of investors baking in geopolitical risk premia, and/or actual stock-out risks in particular commodities. And that’s the thing that you typically see short term. The long-term question is whether or not that short-term crisis fades away and stabilizes, or actually creates some kind of enduring long-run shift. Now, historically, geopolitical shocks are short lived and don’t cause this kind of permanent damage. But there are stories and experiences in the past where what might have been a shorter-term shock turns into a new normal of extreme prices. Most of the time, you’d say these types of things are short lived and subject to normalization. But yes, there’s always this sort of possibility of the long-term structural shift where everything from consumer behavior to corporate investment policy and, in the long run, even inflation expectations themselves start to be altered as the shock morphs into something more permanent.

Where global listed infrastructure might be impacted first

VC: If we thought about infrastructure itself, I think the most obvious place that would be hurt the most would be transportation-linked infrastructure. Here you could think about airports, seaports, toll roads, even railroads. What happens with a war like this that hits prices, particularly of fuel, you’re going to not just disrupt potential travel routes, you’re going to change the fundamental cost of them. You’re going to change trade volumes and how goods move around the world. In the extreme case, you get impacts on overall economic activity: fuel shortages, reductions in airline flights, global shipping slows. The flip side of that, though, is that there are other things that tend to be more resilient. The things that are going to jump to mind are going to be regulated and contracted type of infrastructure. So, electric, gas, utilities, and midstream energy pipelines. And also intuitively, these are, within infrastructure, some of the things that have held up a little bit better.

How the inflation-hedging characteristics of real assets might kick in

VC: When it comes to inflation hedging and the inflation sensitivity of real assets, it’s pretty robust, regardless of the source of the inflation. But very often what causes the initial inflation spike is something energy related. And there, I would say you have a really long history of diversified real-assets allocation that has resource equities and commodity exposure in it — and hopefully some infrastructure and even some real estate — that likely results in outperformance of these types of assets. From where we stand right now, just to kind of bring that home, if I look at some of our flagship portfolios right now, they’re up for the year, anywhere from, say, 8% to 10% against a global equity index that’s down 3% or so, and U.S. stocks down closer to 5%. So, we would expect that the typical inflation hedging, positive inflation sensitivity of real assets works against a backdrop like this. It should surprise no one that real assets have handily outperformed broader global equity indices year to date.

And finally, what’s the bottom line on investing in real assets during times of conflict?

VC: The takeaway for advisors, I think, is that, look, real assets have a demonstrated history of providing a kind of resilience and diversification precisely during times of conflicts like this. But that doesn’t mean that I encourage everyone to sell everything and pile into real assets. I led with the view that these things are just very difficult to predict. It can be very easy to convince yourself that you should trade and that you should jump in and do something. But if you’ve thought clearly and developed a plan, you should stay disciplined and stick to it. Stick to your strategic principles. Don’t panic real and just realize that, ‘Hey, I’ve got real assets in my portfolio. We hold them for a reason. One of those reasons are stagflationary type impulses or shocks, like what we appear to be experiencing right now.’ If you’re going to do something, maybe it’s make prudent adjustments. But don’t abandon your long-term objectives. Don’t fall prey to knee-jerk reactions in front of an episode like this. There’s a long history telling us that those who jump the gun, so to speak, well, it typically doesn’t work out very well.

Well, those are today’s Soundbites, brought to you by Investment Executive and sponsored by Canada Life. Our thanks again to Vince Childers of Cohen & Steers. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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