Making the case: Real assets in uncertain times
Could the new year bring rising prices? And, if so, where might investors find a hedge against inflation? BNY Mellon senior portfolio manager Jim Lydotes makes the case for real assets.
With one of the most volatile years of recent history behind us, the time may now be right to ask: what comes next? If recent pronouncements from global intergovernmental agencies are anything to go by, we’re not out of the woods just yet.
The IMF in its latest World Economic Outlook, said the global economy is likely to have experienced a 4.4% contraction in 2020 and is forecasting only a partial rebound to 5.2% growth in 2021. Overall, this would leave 2021 GDP well above six percentage points lower than in the IMF’s pre-COVID-19 projections.
Against the backdrop of this once-in-a-generation economic dislocation, fiscal and monetary policy have been the watchword of central banks and governments the world over. Global public debt is likely to have hit a record high of almost 100% of the world’s gross domestic product in 2020, according to the IMF, and expectations are for government debt to rise significantly in proportion to national income in most advanced economies through the coming year.¹
In the US, the Federal Reserve (Fed) slashed interest rates by a full percentage point to effectively zero and launched a US$700bn package of quantitative easing (QE). This was accompanied by the US$2.3tn Coronavirus Aid, Relief and Economy Security Act (CARES). In Europe, the European Central Bank (ECB) extended its QE program by more than 750 billion euros.²
No surprise, then, that for many, the question now is whether a return to inflation might be in the cards. Positive news on a potential Covid-19 vaccine was the catalyst for a steepening of the yield curve in November 2020. Around the same time, tentative signs of a switch in equity investor momentum away from growth stocks in favour of value stocks told a similar story. Both might point to a fundamental rebalancing of macro-economic assumptions in a post-pandemic world.
In the face of such uncertainty, then, where might investors turn? According to Jim Lydotes, BNY Mellon senior portfolio manager, infrastructure assets have their appeal. They can be defensive, relatively stable, and yield-generating. It is, therefore, understandable if they are often described as “bond proxies” and have, accordingly, tended to attract income-focused investors. “Regardless of the prevailing economic backdrop, demands for assets, such as toll roads and regulated utilities typically remain strong,” says Lydotes.
And while bonds and infrastructure do share similar characteristics, the longevity of our current low inflation environment means that many investors have forgotten the one key difference that distinguishes the two: infrastructure’s value as an inflation hedge.
Here, Lydotes suggests viewing inflation protection as an undervalued call option embedded into infrastructure assets. As we have already noted, the prospect of inflation is so foreign that in recent years protection has not been priced in, but investors will put a value on that option “as soon as they get a whiff of rising prices,” he says.
Furthermore, Covid-19 has added a new dimension to the listed infrastructure story. Even as recently as 12 months ago, it would have been easy to argue the asset class was broadly similar to most of its diversified real estate peers. “Now,” Lydotes says, “the pandemic is posing a secular challenge to many sectors of the property market.” This is particularly true for sectors such as hospitality where second- and third-wave lockdowns have brought many hitherto profitable businesses to their knees. In contrast, listed infrastructure with its access to stable, recurring income streams stands apart as an asset class relatively unscathed by the worst of the pandemic.
Gaining access to infrastructure assets is also relatively straightforward, says Lydotes, with multiple avenues of exposure available: direct investment, listed equities, funds, or ETFs.
“In my view, there is considerable value to be found in listed equities,” he concludes. “Over the past five to 10 years, a lot of capital has focused on the private space, and the multiples that private infrastructure funds have been willing to pay for these assets are continually being bid up. As a result, in the past three-to-five years, valuations in the listed space have become more and more compelling.”
SURE (Support to mitigate Unemployment Risks in an Emergency) bond issuance support for EU countries
¹ Financial Times: ‘IMF says austerity is not inevitable to ease pandemic impact on public finances’, 14 October 2020.
² KPMG: ‘Central Banks respond to the pandemic’, 16 Nov 2020.