Exploring the real benefits of liquid real assets
Category: Asia, Global
Cohen & Steers is a leading global investment manager of liquid real asset solutions. Founded in 1986, the firm was the first investment advisor to focus on REITs, one of the original liquid real assets. In the years that followed, the firm became recognized as an industry leader in the management of global listed real estate portfolios. This longstanding expertise was an ideal platform for building a deep global presence in the other major liquid real asset classes including global listed infrastructure, master limited partnerships (MLPs), commodity futures and global natural resource equities. Headquartered in New York City, with offices in London, Hong Kong, Tokyo and Seattle, Cohen & Steers manages $49.0 billion¹ for institutional and individual investors around the world.
What is Cohen & Steers' experience in the real assets markets?
Cohen & Steers has been managing portfolios of global listed real estate for more than 25 years and global listed infrastructure for over a decade. More recently, the firm’s extensive experience in global listed infrastructure, including utilities and gas pipelines, provided a natural springboard for launching a standalone strategy focused on companies in the US midstream energy sector, many of which are master limited partnerships. This industry has experienced exponential growth as a prime beneficiary of the North American energy renaissance.
In 2012, Cohen & Steers launched a real assets strategy, which includes allocations to global listed real estate, global listed infrastructure, commodities futures and natural resource equities.
Why is now a good time to invest in real assets?
We believe that asset diversification is more important today than in any time in modern history. For more than 30 years, the returns from a traditional portfolio construction—generally balanced between equities and fixed income—have been buoyed by the great bull market for bonds. But now, the pending withdrawal of quantitative easing and other factors are pointing to a far less certain future for fixed income markets. Should interest rates move back towards historic norms, bonds may become less effective in offsetting the inherent volatility of stocks.
But it is important to point out that real assets like real estate, commodities, natural resource equities and global listed infrastructure all have the potential to perform well across many market regimes. In particular, securities backed by tangible real assets may especially attractive should the global economy face another inflationary cycle, perhaps as a long-term consequence of quantitative easing.
How do you define liquid real assets?
Real assets are backed by tangible, hard assets whose values are driven by barriers to supply and rising replacement costs. We define liquid real assets as asset classes that offer these characteristics and that are publicly traded.
Liquid real assets are often considered alternative strategies and investors lack consensus in how to define and allocate to liquid real asset strategies. Generally speaking, the investment objective of alternative strategies is to enhance portfolio diversification and improve risk-adjusted returns over time. Liquid real asset strategies pursue diversification through asset classes and sectors with unique underlying asset economics and/or different business-cycle sensitivities. Real assets, for example, have historically tended to outperform during episodes of unexpected inflation and, more generally, at late-stage turns in the business cycle. The benefits of liquid real assets are primarily dependent on underlying asset performance over time, the expertise provided by active management, and the prospects for differentiating performance during periods of below-average stock and/or bond performance.
What are the benefits of allocating to liquid real assets?
In a word, diversification: Today, investors need to look beyond stocks and bonds to include asset classes that can diversify a portfolio’s drivers of risk and return. Real assets can address this need, because the economics of the underlying assets and their sensitivities to the business cycle are distinct for each category. For example:
Commercial Real Estate. The cash flows from commercial real estate are derived from diverse property types with a variety of lease durations and structures, ranging from days (hotels), to months (self storage) to many years (health care and industrial property types). Sectors with shorter lease terms can adjust rents if inflation moves higher in periods of economic expansion; longer-lease sectors tend to be more defensive, with lower but more stable bond-like returns.
Commodities. Unlike equity returns that represent a discounted value of future cash flow, commodity returns are tied to near-term economic trends and the dynamics of supply and demand. Often, returns are event-driven and concentrated in short periods of time. Commodities also have a high correlation with inflation. These factors typically lead to higher volatility and low correlations with equities and fixed income.
Natural Resource Equities. Natural resource equities can serve as a real assets complement to commodities. As equities, their return profiles tend to be out of phase with commodities and typically lead the cycle. Investors can also access commodities exposure in categories not found in futures markets, such as iron ore and uranium, as well as potash and certain other agribusiness segments.
Global Listed Infrastructure. Infrastructure securities tend to be less volatile than other equities, given the stability of cash flow derived from the essential services they provide—for example, energy transmission, utilities, transportation, communications—and have characteristics of monopolistic businesses. At the same time, cash flows from infrastructure assets are often tied to inflation.
One way to test the diversification potential of an asset is to measure performance over periods when stocks and bonds are simultaneously underperforming their long-term averages. Exhibit 1 below summarises the 40+ year performance of four liquid real asset categories—real estate securities, commodities, natural resource equities and listed infrastructure. Notably, the liquid real asset categories assets significantly outperformed stocks and bonds when the returns of these latter two asset classes simultaneously fell below their long-term averages (based on rolling 12-month index returns).
How do you manage risk in real assets investing?
While we don’t target a specific level of portfolio volatility, our expectation is that the diversified real asset portfolio will carry lower volatility at any point in time than the global stock market. Most of the time, our benchmark or policy construction works well to deliver this outcome, but sometimes it is necessary to employ a more direct risk management approach, such as through short-term or tactical holdings of lower-risk fixed-income securities and/or the purchase of protective put options and related hedging strategies.
On the active risk side of the equation, we establish clear benchmarks and active risk guidelines for each “sleeve” of the portfolio and expect managers to operate within those constraints. Additionally, because we take a more tactical approach to top-down allocation, when it comes to portfolio construction, we pay careful attention to the risk impact of how the various betas and alphas in the portfolio are married together—basically, we work to understand and manage how risks from both the top-down and the bottom-up come together in the portfolio.
Importantly, though, staying true to our long-term, strategic research conclusions, we also have in place certain allocation guidelines, limits, and ranges that are intended to ensure that we remain well-diversified across the categories of real assets at all time. While we believe real assets are fertile ground for alpha opportunities—again, from both the top-down and the bottom-up—we strongly believe that achieving good outcomes over time depends on staying diversified and developing an understanding of the sources and impacts of a large variety of risk factors that may impact the portfolio.
How do liquid real assets strategies complement private real asset investments?
In our view, listed and private investments in real asset categories play complementary roles as part of a diversified portfolio, providing two different approaches to investments with similar business characteristics. Liquid real asset investments can complement private investments by adding liquidity, enhancing diversification and providing real-time market pricing.
First, listed markets provide a higher level of liquidity relative to the long lock-up periods and limited secondary markets for private investments. These securities can be bought and sold at any time, while private investments can take several years to fully invest and can last anywhere from five to 15 years. Market liquidity permits the construction and rebalancing of portfolios in relatively short periods of time so investors have the ability to reflect their real-time market views in their portfolio.
Investing in liquid real assets can also significantly enhance the diversification potential of a real assets portfolio. Private investments generally own a limited number of assets or properties, while listed strategies typically hold over 30 securities, each one owning numerous assets. Therefore, listed investments do not require investors to commit the high levels of capital needed to achieve similar diversification through private investments.
Listed investments also offer transparent, daily valuations while private investments typically rely on infrequent, appraisal-based valuations. It is our belief that true value is ultimately determined by the price someone is willing to pay for an asset.
Given the attractive features liquid investments offer, we believe more institutions will incorporate long-term holdings in listed real assets as an integral part of their real assets allocation.
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Head of Institutional Marketing
and Client Service – Asia
1 At March 31, 2014.