Real assets, such as commercial real estate and infrastructure, are taking on greater importance as safe haven assets.
Investment manager JP Morgan Asset Management has issued the latest edition of its annual publication, Long-term Capital Market Assumptions, forecasting that global economic growth will fall 20 basis points in 2020 to 2.3 per cent, global inflation will remain unchanged at 2.2 per cent.
On the investment front, JP Morgan expects global equities to rise 6.5 per cent next year, while the outlook for fixed income returns is “bleak”. It suggests looking for alternatives when it comes to defensive assets.
JP Morgan Asset Management global strategist Patrik Schowitz says portfolio protection is at the forefront of investors’ thinking in the current late cycle environment. Equity markets are near all-time highs, bond yields are at lows and geopolitical risks are increasing.
Schowitz says: “Investors should be asking how their assets will fare in the next downturn and what they can do to build more resilient portfolios.
“Over the past 30 years bonds have served well as diversifiers, providing both income and capital appreciation. Investors were, in effect, being paid for adding portfolio insurance.
“This is changing. A large proportion of developed market sovereign bonds now yield zero or less. With the advent of negative bond yields, the opportunity cost of holding bonds is rising.”
JP Morgan Asset Management global market strategist Kerry Craig says stable and high quality income streams from core real estate and infrastructure investments provide a strong offset against their lack of liquidity.
Craig says: “For investors who are able to hold these assets through the cycle, select real assets bring diversifying properties to portfolio construction.”
In a downturn or period of high market volatility, investors should seek to stay solvent, keep cash flow stable to meet required outflows and have a little “dry powder” to capitalise on opportunities from market dislocations.
For some investors, traditional high quality bonds may still be the most appropriate safe haven asset. But for others, a wide definition of what constitutes a safe haven is essential to optimal portfolio design.
Craig says: “Real assets, such as commercial property and infrastructure, do not fit neatly into a traditional definition of safe haven assets.
“These assets, particularly property, have experienced significant drawdowns during recessions and market corrections and in their unlisted form are not highly liquid or readily converted to cash.
“However, real assets can help provide investors with a key survival skill: keeping cash flows stable to meet required outflows.”
According to JP Morgan’s analysis, the big fall in commercial property assets during the financial crisis can be seen as an outlier, because the crisis had its roots in a housing finance crisis and the performance of real estate assets was disproportionately affected.
Commercial real estate has high quality income streams. The income can smooth out total return performance, providing a buffer against capital depreciation and needed cash flow during times of stress.
Infrastructure investment projects could also be suitable diversifying safe assets for specific long-term investors who can hold them through the cycle and harvest the illiquidity premium embedded in their pricing.
JP Morgan is forecasting that direct holdings of US commercial real estate will return 5.8 per cent next year – up from 5.75 per cent this year. It is forecasting that global real estate investment trusts will return 6 per cent next year – unchanged from 2019 performance.
The commercial real estate industry also faces significant structural change that we believe, when considered holistically, will tend to have a positive impact on the sector’s returns.
“First, we see that that retail share of the sector is falling and is now close to the industrial sector’s share. Additionally, more specialized and faster growing property types, such as cold storage and data centres, are likely to expand their benchmark shares.”
It is forecasting that global infrastructure will return 6 per cent next year – unchanged from 2019 performance.
“We expect increasing investor demand to be supportive of valuations.”
These are among the highest returns in its outlook for 2020.
Among local investment managers specialising in real assets, the RARE Infrastructure Income Fund has holdings in the Spanish power company Red Electrica, Canadian energy companies Emera Inc and Hydro One and the Australian toll road operator Transurban.
The Legg Mason Martin Currie Real Income Fund is investing in the office segment of the REIT market and some regulated utilities, particularly gas and electricity suppliers.