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Written By: Pádraig Floyd |
Pádraig Floyd looks at how insitutional investors are increasing their expsure to real assets such as timber, agriculture, housing and infrastructure.
For decades, institutional investors largely adopted what became considered a balanced approach to their investment strategy. That consisted of a large allocation to debt – government and corporate bonds – and a larger allocation to equity by owning parts of companies through holding publicly traded equity.
Some investors considered other investments, including private equity, commercial property and infrastructure, for instance, but these were often considered too racy for the average pension fund.
Certainly, the risk profile was considerably different – higher, longer, etc – and the assets required additional due diligence, which costs time and money. But the structures were often considered to favour the investment partnerships who would have exited long before the long-term investor had seen much of a return.
A new perspective
Times change, and so do attitudes, not least concerning the material importance of environmental, social and governance (ESG) factors when investing In different markets.
ESG has been a catalyst for increasing interest in what were considered “alternative assets” – for instance private debt – and not least those that come under the heading of “real” assets.
Now, they’re not considered real because the others are fake. They are so called because the underlying assets exist in the real world, beyond the confines of a financial instrument. This includes assets such as timber, agriculture and a vast range of infrastructure projects from roads, bridges and airports through to renewable energy.
Institutional investors are by and large increasing their exposure to real assets despite a challenging interest rate environment, says Jeroen van Rooij, head of Benelux and Nordics distribution, Fiera Capital, though not in an indiscriminate fashion.
“Sophisticated capital is, in particular, seeking pockets within sectors like agriculture and timberland, renewable infrastructure and operational real estate, where they benefit from low correlation and a degree of inflation-hedging, to carve out a more efficient risk frontier to a diversified portfolio construction.”
There are considerable – and growing – differences between demand for some of these assets in different jurisdictions.
“The US, UK and Europe have very different legislated regimes to tackle inflation and boost economic productivity,” says van Rooij. “They’re also exposed to different issues across real assets, from competition in infrastructure, to refinancing in real estate.
“But the core question for institutional investors is whether governments are ultimately responsive to, and welcoming of, private capital.
“We could write tomes about how key economies diverge and the world is de-globalising, but the fact is capital remains highly mobile and investors prioritise favourable regulatory environments that allow for capital to be absorbed and easily deployed to realise financial, social and environmental returns at scale.”
A popular choice
Real assets have been in high demand, with persistent demand from LGPS funds for three or four years, says Andrew Singh, head of real assets at Isio, particularly in two main areas – infrastructure and real estate.
Infrastructure seems to be getting more attention at the moment, partly because it’s performed better, says Singh, but there’s also the angle of renewable energy. So there’s a big ESG angle to infrastructure and many of the new allocations are going towards renewables.
Unlike private sector DB funds, LGPS funds will probably have held larger equity allocations as part of their growth assets. A combination of good investment strategy and a Bit of good luck means they are well funded and can afford to take a bit of risk off the table, balancing that with managing employer contributions.
“We’re typically telling clients they either want to diversify or reduce their equity allocation and allocate that to another area,” says Singh. That may well be credit, but it has been increasingly into real assets, because they are expected to generate a decent level of return while protecting the funds against inflation.
“That’s quite a good story,” says Singh, “but clients are also looking for an ESG angle, because almost any new investment must have positive ESG impact.
“Real assets offer a host of opportunities and local authorities can take advantage of those while corporate schemes have liquidity and risk issues and insurance companies have their own limitations, too. So it’s a prime opportunity for local government schemes.
“Five years ago, we would split allocations between commercial property, residential property, infrastructure and renewables, but now we’re advising clients to have a real asset allocation and then look at how they want to mix the different private market exposures.”
Looking for the real deal
The shift in interest rates – and therefore bond yields – has also encouraged some of Singh’s clients to look beyond the core infrastructure they favoured before. As a yield of 6% can be had from buying a public credit, which is completely liquid, some may look to take on some of the development risks in a core plus type of mandate.
“We’ve seen that shift to back end infrastructure and property, and that tends to push more towards development rather than brownfield assets,” says Singh. “But the thing that’s probably most on trend is social housing and clients have allocated there quite a lot.”
Social housing has performed well, it offers a diversifier in the portfolio, but its impact is very different and ticks a number of boxes beyond those based solely on investment criteria.
“Everyone has been loading up on climate [the E of ESG], but social housing has a considerable of social impact climate.
“So there’s been a shift from traditional core infrastructure funds for toll roads, bridges, utilities, etc, towards what we now call ‘Infrastructure 2.0’, consisting of things like renewables, social housing, green tech and green energy utilities. It’s a different way of accessing that ESG theme.”
Of those assets that Singh has outlined, natural capital – assets that come from the natural world, such as timberland, agriculture, marine, etc – will be high on the agenda for many local authority pension funds.
“Agriculture and timberland are robust inflation-hedging asset classes that have also generated consistently positive returns,” said Rooij. “Historically, natural capital has been a niche sector. But there is overwhelming demand among institutional investors in Europe to invest in scalable portfolios that offer capital appreciation and cash-on-cash yield, while also creating positive environmental outcomes.”
It’s not unusual, in fact, it’s natural
Heather Fleming, head of institutional at Gresham House believes many allocations over the next couple of years from LGPS funds will be related to natural capital.
“For us, that definition includes sustainable timberland and vertical farming, which sit within our sustainable inference of biodiversity creation, but it is the carbon credits that will be one of the key drivers,” says Fleming.
Biodiversity has been something of a slow burn, but only relatively speaking, as ESG in its various forms has spent decades before becoming a success in the investment strategy world.
A new white paper from Pensions for Purpose and Gresham House shows just how attitudes towards biodiversity have changed in the past couple of years.
Even though half of UK asset owners do not invest in natural capital, the other half already does, or intends to in the next 18 months.
More than seven out of 10 (73%) would invest in natural capital as part of a their climate change strategy and almost six out of 10 (59%) would allocate up to 3% to the asset class.
Affordable housing is another area likely to see massive growth, regardless of any government encouragement or edicts, because there is such a requirement across both the mainstream private rented sector and social housing.
“There is a fundamental problem within the UK of people trying to get onto the housing ladder and we believe shared ownership is one of the mechanisms to help with that,” says Fleming, and that is one area of focus that she sees as fitting within sustainable infrastructure.
In May, Gresham House announced it had received additional commitments from Gloucestershire and Devon pension funds for affordable shared ownership investment across the UK, but also within their own counties.
Ain’t nothing like the real thing
Real assets will continue to find favour with asset owners, particularly in “highly defensive sectors that are supported by proven demographic and supply-led trends are our favoured investments,” says Rooij.
“In real estate that would be multifamily, logistics and private debt where we can fill a capital gap left by commercial lenders; in infrastructure, it’s the support needed across the capital stack to operationalise the new economy.”
These assets are becoming increasingly important because funds are seeking ways to differentiate and increase diversity within their portfolios. But it is also clear that beyond diversification they offer opportunities for “real” financial returns.
Above and beyond that are the possibilities of alignment with other, socially impactful metrics that local authorities are simultaneously pursuing.
While climate has been a key focus for many funds, assets such as timber and sustainable agriculture – as well as the built environment – heavily influence success in the field of biodiversity, which is becoming increasingly important to institutional investors, not least because they may soon be reporting on their efforts.
The phrase “as safe as houses” may not be one the typical investment consultant would consider using in these highly regulated, compliance driven days, but it nicely encapsulates what anyone wants from an investment. It is something they can understand – even touch – because it actually exists and can be shown to be doing good for the people to whom they must answer.
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