Our Real Assets House View brings together the views and analysis of our investment teams in real estate, infrastructure and private debt.
Economic context: Slow growth supporting low rates
A ’lower-for-longer’ environment for interest rates is likely to persist for a number of years. The effective absence of inflation pressures alongside modest growth prospects at best, means that central banks are set to stay in accommodative mode for some time, even if there is limited scope for additional stimulus. The next tightening cycle looks a while off. However, we do expect a reversion of interest rates towards their long-term average over the next ten years.
In that context, we see three big themes driving real asset markets over the medium to long term.
At current levels, the yield premium for real estate (over government bonds) is high by historical standards.
‘Lower for longer’ supports long duration assets value
The ‘lower-for-longer’ interest rates will extend the real assets investment cycle. At current levels, the yield premium for real estate (over government bonds) is high by historical standards. This is expected to continue in the medium term, with low rates supporting valuations. Yet, for long-term investors, real estate long income is expected to deliver higher income than traditional real estate, particularly as the maintenance costs are borne by the occupier.
Premia unlocked by exploiting complexity
Uncertainty over global growth means institutional investors will keep looking to real assets for diversification and a potential illiquidity premium (i.e. a higher return than the yield of a comparable bond). But the weight of capital targeting the sector has pushed yields down. To unlock more attractive returns while staying within risk tolerance, investors need to be well placed to exploit complexity. That could be achieved through deep expertise of specific markets, a specialist understanding of a particular sector, or structuring complex finance transactions, for example.
Opportunities exist in real estate development where demand is robust and supply is constrained.
More operational risk is also being taken. In real estate, lenders and owners are becoming increasingly aware that maintaining and growing income requires more active management. Opportunities exist in real estate development where demand is robust and supply is constrained. Complexity can also generate an additional premium in the debt market – private structured finance transactions can attract significant premia over similarly rated public bonds.
ESG becomes non-negotiable
Environmental, social and governance (ESG) factors are already important considerations for many real asset investors. However, with potential exposure to material risks on one hand, and better outcomes for society on the other, ESG will become impossible to ignore. This represents an important step-change: covering ESG is no longer a tick-box exercise. In 2020, ESG risks should be actively monitored and managed.