Public sector investors around the world are set to boost their exposures to real assets in the coming year, according to the latest Global Public Investor survey from independent think tank the Official Monetary and Financial Institutions Forum (OMFIF) .
The survey found almost a quarter of respondents (24%) intend to up their real estate holdings over the next 12 months, while 37 percent plan to invest more in infrastructure. At the same time, 26 percent aim to cut their allocations to low-yielding developed market government bonds.
“The majority of public sector investors are seeking stable and secure income streams over an extended period of time,” notes David Green-Morgan, Global Capital Markets Research Director with JLL. “Real estate and infrastructure are ideally suited to this demand.”
Public sector investors encompass a range of organizations, from central banks and sovereign wealth funds to public pension funds. OMFIF puts their total holdings at an estimated US$33.8 trillion.
Historically, government bond yields have played an important role in these institutions’ return strategies. Yet with the extended period of low and even negative bond yields continuing to act as a drag on returns, investors are drawn increasingly to the higher returns offered by real estate and infrastructure. In response, public sector investor allocations to real assets have been on the rise.
“Real assets are proving particularly appealing to those institutions with very long-term liabilities, or those that are building wealth over the longer term, such as pension, insurance and sovereign wealth funds,” says Green-Morgan.
More than a fad
Will this continue? With interest rates in various markets prospectively on the turn – leading to higher fixed income yields, and an uptick in financing costs for real estate and infrastructure projects – it is possible we could see a recalibration in the asset classes’ relative attractions. Nevertheless, the appetite among public sector investors for real assets that was highlighted by the OMFIF survey suggests a sustained, long-term shift.
“Expanding allocation to new asset classes is likely to be a trend among public investors for some time,” wrote former president and CEO of the Federal Reserve Bank of Atlanta Dennis Lockhart in the OMFIF report. “Prospects for growth in advanced economies will be constrained by demographic trends and weak productivity growth. Meanwhile, moderate growth with low inflation will keep interest rates down.”
Green-Morgan likewise expects real assets’ fundamental characteristics will ensure they remain an attractive investment proposition. “Although the financial crisis speeded up the process, this trend of increasing real estate and infrastructure allocations has been occurring for the last 20 years, long before bond yields hit their low points,” he observes. “That is because public sector investors in particular value predictable and stable returns over more volatility. And while the income is the main priority, a major benefit of real assets is that they offer the possibility of capital appreciation.”
The opportunities for investors are widespread too, extending across developed and emerging markets in both the real estate and infrastructure sectors. Inevitably each carries different risks, with lack of transparency and access to good quality information remaining key challenges. Nevertheless, the scale and variety of opportunities should continue to expand, reckons Green-Morgan. And with investors far more global and diversified in their outlook since the financial crisis, they are better placed to take advantage of those opportunities as they arise.
“For example, we have seen the nature of real estate investing broadening in developed markets to encompass student housing, aged care, data centers and other niche sectors,” notes Green-Morgan. “This has been more challenging in emerging markets, where much of the increase in investment has been into the traditional sectors, although residential development is one sector that has proved popular across all markets.”
Ultimately, moves towards better governance and greater transparency will be crucial in increasing the attractiveness of, and flows to, emerging market real assets. As will more appealing pricing. For as Green-Morgan points out: “At present, the price differential is not large enough in most cases to justify the extra work and risk involved in accessing the product.”
Global Capital Markets Research Director, JLL