Focus Group: The real thing
Just under half of the respondents to this month’s Off The Record survey expect their allocation to real assets to increase a little over the next five years. On average, respondents currently invest 24.4% of their fund in real assets – although some investors have a more expansive definition for the term than others. One fund included the 5% it has in private equity, for example; two others included their listed equities; and two even included bonds, without specifying whether these were inflation-indexed.
When asked to define a ‘real asset’, one fund cautioned against forgetting equities, and one declared it an “artificial” concept. One UK fund defined it simply as “one that beats inflation”, while another stated: “An asset whose return profile has a strong correlation with inflation (in the domestic market) over the medium term (over seven years).” A Danish fund similarly defined it as “an asset that would have the double price in an economy where all nominal monetary holdings and debts doubled overnight”.
As such, it is unsurprising that 11 out of 23 respondents mention inflation protection of one form or another in the stated objective of their real-asset allocation, with most hoping that it would help grow the value of assets by more than inflation in the long term. A Danish fund explained: “Both short-term general diversification and long-term inflation protection are important elements.” Among other options, eight respondents said they hoped to simply diversify their growth portfolio.
With that inflation focus in mind, respondents have differing opinions as to which asset classes were likely to provide a positive real return on capital over a 10-year horizon. The majority believe developed market real estate (20 respondents), commercial real estate (19), and equities (21) would do so. Conversely, 10-year nominal US Treasury bonds (21), and, perhaps more surprisingly, precious metals futures and crude oil futures (both 18) are considered the least likely to deliver positive returns.
But as the diverse response to our objectives question suggests, real assets are considered as fitting into many different parts of the portfolio. This might explain why only a few of the 20 respondents said that they had considered creating a dedicated ‘real assets’ or ‘inflation-sensitive’ portfolio. One of those that had done so, a Danish fund, said: “That will be an element of a product hedging wage inflation linked pension liabilities”.
Looking to future intentions, four respondents expect their allocation to increase significantly, while five think it will remain the same. Two believe it will decrease a little, and just one thinks it will decrease significantly. “Real assets are by nature illiquid. Due to Solvency II regulation it will be less possible to keep this type of asset in the portfolio,” said a Dutch fund.
When asked whether governments have a responsibility, or a role to play, in incentivising institutional investment in domestic real estate or infrastructure, 10 of the 16 respondents said no – with one warning that it would be “unwise”.
One Dutch investor said: “They do not have a responsibility, but should be more open to participation by the private sector.” The minority view was articulated by a UK public-sector fund: “Yes, especially if they are funding government projects.”