Alternative Real Assets Compete with Fixed Income
Updated: Nov 19, 2020
By Vadim Mandel, from the LSESU Trading Society
Although fixed income makes up the largest share of institutional investors' portfolios currently, their appeal is diminishing. The monetary policy deployed by major central banks of low-interest rates combined with QE has contributed to low-to negative bond yields. Macroeconomic factors such as global contractions in GDP, increased volatility, and a marginal increase in bond default rates have further reduced investor appetite for FI. This has resulted in many investors turning to real assets to provide income stability as well as portfolio diversification.
It is Pulkit Sharma's (Head of Real Assets at JPM AM) belief that core alternative real assets have half the volatility of public equities and pay up to three times the income of quality investment-grade bonds. "The reality is that core alternatives are the 'new bonds'. The income available from traditional core bonds is shrinking and we're seeing negative real yields in the higher quality fixed income space". This is corroborated by a recent Global Pensions Asset Study by Towers Watson which found that pension funds have been reducing their fixed income and cash allocations to varying degrees since 1995, while allocations to alternative investments have increased from 5% to 18% over the same timeframe.
The long-term outlook for real assets is enticing, especially when considered on a risk-adjusted return basis, relative to most traditional assets and financial alternatives. We expect core real assets to continue to keep on picking up a foothold in portfolios, given the stable and diversifying nature of their return streams, fuelled by income generated from long-term contractual cash flows supported by strong counterparties. JP Morgan AM estimates annual net returns of 6-8% from core real assets, with 70% of the yield generated by income.
Overall, Covid-19 has had a limited footprint on the real assets space, with energy, data goods, and water being minimally strained. Moreover, both logistics and utilities as well as residential segments have also shown flexibility. At the cost of the retail sector, there has been a more profound advance of the e-commerce-driven growth of the industrial/logistics
We see expanding institutional asset flows powering growth and expanding investment opportunities in a plethora of areas which include core infrastructure and transport. These areas are developing into scalable institutional core real asset categories alongside core real estate, and other extended asset class sectors such as data storage centres, health care capacity, and residential rentals. The increased appetite from institutions for investments in global real asset markets should continue to propel growth and diversification of the opportunities provided in this space.
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