Is there is a tension at the heart of this month’s special report? On the one hand, we write about markets undergoing significant change. On the other, we deal with issues arising from the pursuit of dependable, boring, long-term cash flows from real assets.
Anyone who has held mining stocks since China started slowing down knows how painful it has been. But perhaps the worst is over. Shareholders willing to cheer on indiscriminate capital investment during the boom years have since rebelled, management heads have rolled at several big firms, and the new breed has the dividend-and-buyback religion. Starting from such a low base, meaningful capital appreciation could be about to accrue as higher levels of free cash flow begin to be priced into this industry.
Energy and power stocks have always been seen as cash cows – here the change is from stability to uncertainty. The interminable journey towards a single European market is constantly in the background, as well as national and European initiatives to meet emissions targets, but shorter-term concerns also throw upside and downside risks in the path of investors. The aftershocks of Fukushima still rattle through Germany’s energy policy, while shale gas and the crisis in Ukraine potentially offer both the means and the impetus for Europe to wean itself off of foreign fossil fuels.
Change is also under way in commodity futures (pages 55-57). We hear arguments that the recent switch from contango to backwardation in many futures curves is down to secular changes in market structure that should influence the entire complex. Investment bank regulation is putting a lid on speculative, liquidity-providing activity at the back end of term structures, goes one argument; producers prepared to go unhedged during the bull market are more likely to lock in prices now they are range-bound, goes another. Both suggest downward pressure on longer-dated futures prices – and positive roll yields for investors.
Not everyone is convinced. Robert Greer, who oversees commodities at PIMCO, emphasises the idiosyncrasies of different markets – and, indeed, in this report last year the same point was made to support the argument that the diversification benefits from commodities were making a comeback. Nonetheless, one pension fund investor finds the idea of secular backwardation “interesting”. That’s no surprise: his fund started allocating in 2009, not for price appreciation, but for the income from contract-roll returns.
It is this idea of generating income from real assets that rounds off our report. Standard Life argues that unlocking real asset investment from pension funds – a stated objective of Europe’s authorities – means making it a source of cash flows (page 61). It calls for greater development of debt and securitisation markets. Researchers from the Edhec Risk Institute offer a user-friendly framework for measuring the performance of infrastructure debt that should contribute to this objective (pages 62-63). And finally, Brookland Partners outlines some of the mistakes that fed into Europe’s real estate debt debacle, and makes the case that the industry learned a lot from those mistakes (page 64).
So perhaps there is no tension in our special report, after all. From mining to infrastructure, real estate to commodity futures, the focus is on changing real assets into income-generating investments. For investors facing rock-bottom bond yields and tight supply of inflation-linked securities, that would represent a material change.
Martin Steward, investment editor