Meagan Nichols
Answers to our clients’ questions about market action and the market environment in a few paragraphs every two weeks.
In a word, yes, albeit slowly and selectively. Since the US presidential election, the market appears to be pricing in renewed expectations of growth and inflation, both of which have the potential to positively impact real assets in the medium term. Though it’s unclear exactly how the new administration will proceed, the prospect of policy changes and their ultimate impact have the potential to create volatility and dislocations, resulting in winners and losers in real assets.
Within the energy complex, the new administration’s pro-energy policies should provide a tailwind across the industry, with oil producers and pipelines in particular benefitting from deregulation and possible increased government funding. While this tailwind is likely to spur increased production, the impact on the price of oil merits watching, as meaningful production increases have the potential to push oil prices lower and ultimately turn tailwinds into headwinds. Given this dynamic, oil services could be an interesting area to consider as the sector is currently at a cyclical low and will benefit from increased drilling activity.
We are also cautiously optimistic about non-energy infrastructure. Infrastructure spending appears to be a key priority for the new administration. The poor state of US infrastructure creates a fairly solid case for improvement and investment. The intention appears to be to emphasize public-private partnerships rather than exclusively federally funded projects. Setting up public-private programs and projects will take time, and it remains unclear what the size of the program and scope for private involvement will be. Our sense is there aren’t a significant number of “shovel-ready” projects simply waiting to be financed. As such, investment in 2018 is likely to be more robust than in 2017.
In real estate, substantial yield compression and rising valuations in major markets over the last few years would suggest the market is in the later stages of the cycle. On a valuation basis, we see relatively few compelling opportunities in core real estate today, as the quantum of capital searching for yield has driven up valuations globally. In the United States and increasingly in Europe, the value-add and opportunistic opportunity sets are waning as well, though still more attractive than core. Even though the legacy distressed loans and assets held by financial institutions in Europe continue to provide opportunities for managers, economic growth remains elusive and risks are high given upcoming elections. However, high-quality managers with vision and operational skills may still be able to exploit opportunities and add value for investors. Finding managers with proven skill and discipline in identifying and executing on value-add opportunities across market cycles is key for real estate investors. Opportunistic managers with flexible “all weather” mandates that have the ability to buy throughout the capital stack and across the real estate spectrum are also attractive, if they have proven their ability to flex at different points in cycles.
A case can be made for investing in metals & mining, but the devil is in the details. The investment case for mining hinges on the continued increase in global GDP and industrialization. An additional consideration is the prospect for continued economic growth in China, which remains the largest buyer of most industrial metals. Capital markets have been largely closed to mining companies, particularly junior mining companies, which has created an opportunity for private mining funds to fill the financing void. However, many of the best assets are held by the large publicly traded mining firms, which have repaired their balance sheets and are not forced to sell assets, limiting the investment opportunity set for private funds. And implementation remains a challenge—very few compelling private investment mining funds are raising capital in the near term.
Overall, now is a time to pause and take stock of what you own. Review your real assets target and actual allocations; look through your portfolio to see how much you actually own in real assets, as some real assets are likely hiding in other buckets; and assess what types of real assets you own today. Are your real asset positions more correlated to inflation or more equity-like? Revisit the role you expect real assets to play in your portfolio. If you are seeking inflation protection with some diversification, consider adding natural resources equities and commodities at current valuations. If income and diversification are your goals, begin to explore infrastructure and consider some lower risk real estate, real estate credit strategies, and master limited partnerships. Investors seeking more growth would be well served to commit to smaller private equity energy managers that are nimble and able to take advantage of volatility, as well as to select opportunistic real estate managers with the skills necessary to navigate possible distress.
Meagan Nichols is Head of the Real Assets Investment Group at Cambridge Associates.
Originally published on January 31, 2017
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