Commentary: Finding value in real assets as investor inflows accelerate

While individuals remain content riding the stock juggernaut, forward-looking sophisticated investors are increasingly boosting allocations to real assets. This is understandable, as we see numerous positive drivers for these assets in 2019 and beyond.

We believe that one reason for the increased appetite for real assets is inflation. With the last decade characterized by low inflation, many investors are complacent in relation to inflation risks. In an environment where inflation surprisingly accelerates to the upside, stock and bond markets both typically struggle, meaning investors could lose the portfolio diversification benefits.

Valuation is another driver, as many of these assets have only partially participated in the risk-on rally experienced over the past decade. Unlike historically elevated valuations for equities and the still-low bond yields, real assets continue to display solid upside potential.

Real estate displays attractive late-cycle dynamics

Real estate stocks in general are attractively positioned in a late-cycle environment. As the broad equity market adjusts to an environment of peak earnings margins and decelerating growth, we project real estate investment trusts with defensive growth characteristics to maintain a positive earnings outlook that is largely unchanged. Further, REITs may benefit if central banks, particularly in the U.S., slow the pace of tightening.

Within the U.S. REIT market, we have an optimistic view on nearly all forms of rental housing; this is due to favorable demographic growth trends, job and wage growth, as well as rising mortgage rates making home ownership more expensive. We also favor cell towers and data centers, which should continue to benefit from the proliferation of data growth in the U.S. and elsewhere.

In light of our relatively negative view of economic prospects for the U.K., we favor companies featuring more defensive or structural growth characteristics — which will likely remain relatively insulated from an economic deceleration. These include logistics warehouses, student housing, self-storage and health-care landlords. We maintain our negative stance toward U.K. retail.

Property markets in continental Europe are likely to continue to benefit from solid tenant demand in the region, even as economic growth decelerates from above-trend rates. In particular, we favor residential property owners in most markets, as well as properties benefiting from improving demand, but haven't yet been met with commensurate new supply — such as logistics facilities across Europe.

Commodity demand favorable

We expect global economic growth to persist, with improving employment and rising personal incomes in the U.S. spurring consumer spending and business investment. Such conditions should prove broadly favorable for commodity demand.

While recent weakness in commodity markets was in part due to trade tensions, we believe the impact of trade tariffs on commodity fundamentals will be modest, aside from a select number of commodities directly targeted by China.

As for oil, the global crude market outlook remains fundamentally and structurally constructive. Strong and stable demand growth, an accommodative OPEC+ committee, normalized inventory levels and heightened geopolitical risks — especially the U.S. sanctions on Iranian oil exports and Venezuela's internal strife — has led to a structural decline in oil production. We believe this environment should support Brent prices in the $65 to $75 range this year.

Agribusiness stands out

While it is apparent that weakness in the natural resource equity markets has been in part due to trade tensions, we believe the direct impact of trade tariffs on commodity fundamentals will be modest.

We are cautious on the metals and mining sector near term, although valuations are still reasonable. We await more clarity on the trade war until we can become more confident the U.S. will not cripple China's investment plans with additional tariffs or unrealistic demands for economic change.

Agribusiness remains a top sector under our risk-parity approach. Within the sector, we believe out-of-index packaged foods and meats, as well as the construction machinery subsectors, appear to offer the best growth prospects. Fertilizer companies also are seeing improved supply/demand fundamentals, which may support earnings in the near term.

Defensive stance within infrastructure space

We have taken a more defensive stance within our infrastructure portfolios, given our view of a continued economic slowdown and rising political uncertainties globally. We are optimistic on U.S. water utilities, with growth driven by critical pipeline replacement projects across the country. Consolidation of the largely municipally owned sector is an additional tailwind.

We also see secular tailwinds for towers. Tower owners are well positioned to benefit from long-term secular demand growth for wireless data services and the adoption of next generation standards — such as 5G — which should drive increases in wireless carrier spending and leasing activity.

Midstream energy is also a favored subsector, as we believe it is benefiting from two key themes. First, fundamental tailwinds are growing, as North America increases its market share of global energy production. This increases capacity utilization of existing assets and, in some cases, drives the need for new infrastructure development. Second, management teams are transitioning to what we call the "Midstream 2.0" business model.

This model recognizes the importance of corporate governance and investor alignment, strong balance sheets and return-based performance metrics. While a painful transition over the past several years — a period in which many companies recapitalized and significantly cut distributions — we believe these actions set the framework for stronger performance going forward.

Vince Childers, New York, is head of real assets multistrategy at Cohen & Steers. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.