Real assets are the fundamental building blocks of productive societies. They are essential to the creation, movement and storage of raw materials, goods, people, data and energy, defined both by their physical attributes and their investment characteristics.
But the range of assets and investment opportunities that fall within these parameters has grown significantly over the past two decades. “The tent has expanded,” says Bernie McNamara, head of client solutions at CBRE Investment Management. And institutions must overhaul their approach to portfolio construction to reflect the real assets reality of today.
There is still much that unites real assets, of course. “Real assets are the tangible, essential building blocks of productive societies. They offer a ‘real’ inflation-sensitive return. There is generally an income component to returns, typically underpinned by long-term leases or use arrangements, and there is also capital appreciation potential, diversification versus stocks and bonds, and, importantly, downside resilience in the face of unforeseen market events, such as covid,” McNamara explains.
But the real assets universe has become both wider and more nuanced. “Once dominated by real estate, real assets allocations have grown to include other categories, like infrastructure, which has now become an important second pillar alongside real estate in most portfolios,” says McNamara. “We have also seen the addition of timber and farmland, a shift from a purely private markets approach to private markets plus listed and an evolution from pure equity investing to include real assets credit as well.”
This evolution means that investors need to not only consider the diversification potential of real assets in the context of other parts of their portfolios, but also the diversification that real assets offer between one another. “Real assets are defined in part by their similarities but, critically, also by their differences,” McNamara says.
“There is relatively low correlation not only with public equities, but also between the different asset classes that make up real assets. While there are some shared, macro influences on many real assets, by and large performance is driven by local market drivers. The performance of an office building in New York has very little to do with that of a logistics asset in the Inland Empire, a solar installation in Japan or an airport in Europe. That has important connotations for portfolio design.”
A holistic approach
Meanwhile, not only are the parameters of real assets expanding, but allocations are soaring. “Typical allocations have grown from 5 to 10 percent, with a focus on domestic or regional real estate, to 15 to 20 percent-plus across several different real assets sectors for many investors,” says McNamara. That means that ad hoc, tactical decision-making based on a series of isolated asset classes or geographies will no longer suffice.
“There must absolutely be a thoughtful, holistic and data-driven approach to portfolio construction within and across real assets,” McNamara continues. “It is time to start using the same kind of language, asset allocation methodology and risk management frameworks that have been used in other, more traditional parts of the portfolio for years.”
Indeed, the firm has restructured and rebranded its own business to reflect this evolution, uniting its global infrastructure and real estate subsidiaries under the new CBRE Investment Management name last year. CBRE Global Investors and sub-brands Caledon Capital Management, CBRE Clarion Securities and CBRE Global Investment Partners are all now unified within a $141.9 billion global real assets investment management platform, which can leverage its combined expertise to drive performance and deliver cross-real-assets solutions for clients.
“The conversation now starts with portfolio design. What do real assets need to do in a particular portfolio? What issues are they trying to solve? That high-level and long-term strategic lens is vital in determining the ‘pie chart’ for a particular client. Then we can start populating the pieces of the pie with underlying investment strategies that dovetail with the holistic, overall plan.”
Of course, the nature of that plan will vary depending on individual client needs. But there are typically some common objectives. “Investors are generally looking for those classic real assets attributes of a return underpinned primarily by income with some capital appreciation potential, diversification, inflation protection and downside resilience,” says McNamara.
“On a blended basis, that ends up looking like a core-plus risk/return profile with a total return target of, say, 8 to 10 percent-plus, for the ‘typical’ long-term investor in the asset class,” he adds.
Stable, income-orientated investments typically will make up the bulk of a client’s allocation – in the range of 70 percent-plus – with the remainder focused on the capital appreciation component. There will be an equity/credit split, often not dissimilar to the 60:40 public market equity/fixed income exposures that investors historically had in their traditional financial asset allocations, as well as a mix across the different real assets categories with an anchor allocation of around 50 percent to real estate, as the largest, most liquid and most transparent real asset category.
“Real assets are defined in part by their similarities but, critically, also by their differences”
There will then be a further, chunky allocation of 30 to 40 percent or more to infrastructure, particularly core/core-plus infrastructure. Again, that offers stable income, some capital appreciation and meaningful diversification, but with the added potential benefit of true downside resilience.
“Truly core/core-plus infrastructure tends to continue to perform, whatever the situation,” McNamara says. “There is also often more explicit inflation protection, which is a high priority for investors right now. The remainder of the allocation goes into other real assets categories including timber and agriculture. Around 70 percent will be allocated to private markets, with 30 percent earmarked for listed exposures, for both strategic long-term benefits and tactical opportunities.”
But while the majority of investors may be chasing a core-plus profile with their real assets exposure, the tumultuous events of the past two years have necessitated a radical overhaul of risk assumptions.
“Historically, investors have viewed the traditional sectors within core real estate and infrastructure as the beta of their real assets portfolios, but covid has exposed vulnerabilities in that approach, particularly for real estate and especially for the office and retail markets,” McNamara says. “In reality, though, risk parameters and allocations have been evolving for years.”
Indeed, according to McNamara, real estate 2.0 began taking shape almost 10 years ago, when the definition of office started to change with the advent of flexible workspaces. At the same time, the rise of e-commerce has had significant implications for logistics, and shifting demographics have impacted residential and specialty needs, including student and senior housing.
“Now we are moving into real estate 3.0 with the rise of growth sectors such as life sciences, self-storage, cold storage and specialty residential, and the danger of having a purely ‘beta’ approach is even more clear,” he says.
“A similar dynamic is playing out in infrastructure where covid has revealed that assets typically deemed core, such as transport and traditional energy-based investments, can actually be highly sensitive to volume and/or obsolescence risk. Infrastructure 2.0 now includes digital assets such as data centers, fiber and cell towers, as well as investments that are more resilient to environmental and/or volume risk, like renewable energy and availability-based green transport. These are the challenges that many investors are wrestling with, whether they have an existing beta-orientated allocation or are starting from scratch and wanting to learn from the lessons of the past.”
Another fundamental change that has taken place over the course of the past decade, of course, is the dramatic increase in focus on ESG. Real assets typically have a significant carbon footprint and therefore a significant responsibility to help drive the sustainability agenda, both by developing new ESG-aware assets and retrofitting and upgrading existing assets.
“You can’t ignore the need for new stock to meet changing demographic and other structural trends. Those needs can’t be met only by retrofitting,” says McNamara. “That said, there are plenty of opportunities, particularly in the office space, where upgrading often makes more sense than tearing a building down and starting from scratch. Yes, some stock will become obsolete, but a lot can be retrofitted to the standards of investors and tenants today with a responsive office strategy.”
Investors in real assets have an important role to play in providing the infrastructure that will transform our society. This means fighting climate change, but also achieving sustainable development by providing essential services from water to fast internet connections to underserved communities.
“In the US, core infrastructure is predominantly owned by the government at a federal, state or local level,” says McNamara. “With the historic $1.2 trillion Infrastructure Investment and Jobs Act, investors will benefit from stronger policy support and funding for investments in clean energies, digital and the rollout of electric vehicle charging infrastructure.”
Investment in energy transition technologies is expected to triple by 2030 so that we shift away from fossil fuels to clean power generation. “The next-generation infrastructure is climate friendly, digitally smart and resilient,” says McNamara. “As we rely more and more on renewable power, we will see a radical transformation in the way our grids operate, but also more energy storage and smart meters. The digital and clean energy themes are dominant in investors’ allocations to infrastructure.”
There is no doubt then that the world of real assets has transformed over the past decade and investors are having to modernize their approach in response. “There is no such thing as a fully future-proofed portfolio; it requires constant care and attention. But those investors that embrace the new and enlarged parameters of real assets with a holistic approach can achieve a real assets 3.0 portfolio within a relatively short period of time – perhaps two to five years depending on their objectives and existing portfolio allocations,” McNamara says.
“Those starting from scratch are probably on the same timeline or may even get there more quickly,” he adds. “Adopting the whole toolkit from the outset can often be more efficient and effective than buying the individual tools one by one.”
Diversifying into listed equities
Investors are increasingly expanding their real assets exposure into listed equities.
This trend is partly informed by what they perceived as a once-in-a-generation buying opportunity that opened up in listed real assets immediately after the onset of covid. “Many investors weren’t set up to act on that opportunity in a co-ordinated way, because they didn’t have a dedicated listed allocation established within their real assets bucket or coordinated through their traditional equities portfolio,” says McNamara.
Investors also see the listed markets as an efficient way to access real estate growth sectors – those opportunities that exist outside the traditional office, retail, multifamily for rent and logistics spaces. McNamara cites specialty residential – including single-family for rent, student housing and senior housing – as well as cold storage, self-storage and life sciences as prime examples. “Many of these growth sectors are most easily and efficiently accessed via the public markets, which means a listed allocation plays a strategically complementary role to private markets exposure,” he says.
Meanwhile, investors are also diversifying their equity exposure with allocations to credit, as they become increasingly sophisticated about the need for downside protection and as they hunt for income in a low interest rate environment. “Private real assets credit is really coming into its own as investors search for yield premiums or yield replacements,” McNamara says. “Just as you see that classic 60:40 public equities to fixed income split, investors are looking to include significant credit allocations in their real assets portfolios.”