<p>As investors continue to transition from financials to real assets, financial experts from Cohen & Steers, Deutsche Asset Management, ETF Securities, and TIAA Global Real Assets discuss the potential benefits of investing in real assets, and share their insights on diversification strategies, risk, potential growth scenarios and more in this latest edition of Masterclass.</p>
<ul>
<li><p>Vince Childers, CFA - SVP, Porfolio Manager at Cohen & Steers</p></li>
<li><p>Mark G. Roberts, CFA - Head of Research and Strategy-Alternatives and Real Assets Platform at Deutsche Asset Management</p></li>
<li><p>Maxwell Gold - Director, Investment Strategy at ETF Securities</p></li>
<li><p>John Goodreds - Portfolio Manager, Agribusiness at TIAA Global Real Assets</p></li>
</ul>
Video Image:
Duration:
0000 - 00:53
Display Date:
Thursday, October 20, 2016
Transcript:
Gillian: Welcome to Asset TV. I’m Gillian Kemmerer. Real assets have dominated the financial media over the past few months with mega investors, from growth to soar is talking about transitioning from financials to real assets while the economy continues to struggle in the stock market and also questions around bond market yields remain. Here to help us understand where the opportunities lie, how to diversify and what are the real assets that make sense for your portfolio, is a panel of experts that represent a multitude of viewpoints. Thank you so much for joining us today and I’m so excited to kick off our discussion, of course, my pleasure. So I’m going to get started with you, Mark, and I’m going to pull up a graphic that I have on Bloomberg, that’s a little bit about the prices – relative prices of real assets versus financial assets starting in 1925 until now. So as you can see we have markings of various geopolitical and economic events. And I will note for any of our viewers that are watching at a later date that this graph was constructed and published in August. So, Mark, starting with you, initial reactions here, and then can you tell us a little bit about what real assets are to you, how you define them and how they fit into a portfolio?
Mark G. Roberts: Sure. And it’s a very interesting chart, for the viewers out there it’s showing the relative prices, I believe, of real assets versus equities and suggesting that there’s some good relative value there today. Another striking point to me is it does start going back to the 1930s. And what I find interesting about that, when you talk about real assets, it’s just the enduring quality of some of these things. So just a little quick little story, the Empire State building, they actually broke ground on it in January of 1930 at a price of about $41 million. At the same time, that day, the Dow Jones Industrial had a price of about 250. Today that is sitting at close to 18,000, so it’s about a compound annual return of about 5%. But if you look at the enterprise value today of the Empire State building it’s closer to $4½-5 billion. That compound annual return is about 6%. Then you sort of dig a little bit deeper and you ask yourself, okay, how many of those companies at Dow Jones are still there today? So there’s this idea of about survivor buys. It might surprise you that there are only three companies in there that were still in there, actually two, one was Standard Oil that turned into Chevron and Exxon and the other one was GE. So ironically both of those are either energy or infrastructure related companies. So you do look at sort of the enduring quality and that’s something that we’re trying to educate and talk to our investors about today. It’s real assets that have some downside protection to them; they’re true hard bricks and mortars. They produce competitive returns and they move in different cycles with other asset classes.
Gillian: And particularly poignant as we sit in the old General Electric building here in Manhattan today. So, Vince, I’m going to come to you. Talk to us a little bit about what you see here and how you define real assets.
Vince Childers: Yeah, sure. Well, I think one of the main things we see on this chart is the influence of inflation cycles on the relative performance of these assets. So I think it’s no surprise to most investors that if there’s a key factor that pulls together real assets as an asset class, is that sensitivity to inflation. And in particular the sensitivity to the unexpected component of inflation, like anything in the world of asset returns, it’s what’s unexpected that tends to give you the above average and below average returns. And so I think the 70s obviously a very obvious period where we had an inflation cycle, and as we look closer to the end of this cycle or this end of this chart what we’ve seen is really more of a disinflation cycle now we’re five or six years into a series of disinflation surprises, so realized inflation was lower than what investors were expecting say 12 months earlier. And so we’ve sort of seen the reversal of that performance in real assets. So when I look at this chart, it seems consistent with everything I kind of know about this asset class. Now, in terms of what we’re focused on, I think it’s worth pointing out that of course a lot of this picture is driven by movements in the commodity complex. So commodity futures as investments as well as resource equities, we’ve had better results, I think most would agree, out of real estate and infrastructure in the last several years. But again kind of having half of your real assets universe, at least for us, being hurt by the disinflation surprises we’ve had over the last five years or so has made the big difference. But as was pointed out, you know, it’s these types of cycles where you’re reaching what looks like a bottoming process where often you have the best future potential for returns.
Gillian: And I’d love to drill a bit further down into the commodities bottoming out a little bit later. So we’ll definitely come back to that. Maxwell, I want to get your reaction to this as well. But you introduced me to an interesting acronym when we first spoke and that was TINA. So it’d be interesting to hear what that is and how it plays into our macro backdrop right now.
Maxwell Gold: So I definitely agree with what has been said about the chart and how it really reflects the long term inflation cycles as well as growth cycles and credit cycles. And really where we are is at the tailwind of a 30 year deleveraging cycle and interest rate reduction cycle. But to your point the acronym, TINA has been getting a lot of press so far this year and it stands for There Is No Alternative. And I think that has pushed a lot of investors in a very challenging market environment where we do see equity valuations a bit stretched compared to recent historical averages, interest rates continue to be very low based on accommodated policies and the hunt for yield by investors stretching to get their cash flows and their yield on an annual basis. But really I think what we’ve seen is, is a transition into other asset classes that are beyond the traditional stock bond asset classes. And we’ve seen a lot of inflows so far this year into the commodity space, into the real asset space, not just from a diversification standpoint or a potential relative value standpoint. But as well as sort of it’s the next iteration, next step of options in terms of a very challenging investment landscape where we are seeing expected returns across asset classes to remain, continue low while we do see expected volatility, continue to rise. So it’s a very flat efficient frontier as what’s referred to in layman’s terms for investments. But overall, you know, we do see this as a continued, you know, motivation for investors to continue to look outside the box for opportunities of value for potential real returns. And we do see that, you know real assets in particular, commodities as an option that will continue to add further diversification for investor portfolios.
Gillian: Great. And you actually teed me up perfectly for my question for John, you’re an agricultural expert, we just talked about capital flowing into this space. As investors seek to increase their exposure to real assets in this hunt for yield, are you concerned about too much capital, chasing too few deals and how might that potentially drive up land prices and reduce your returns?
John Goodreds: It’s a good question, it’s a relevant question. And from what we’ve seen, real assets broadly speaking, many investors are starting to invest, many are still researching it. So it’s still a relatively underpenetrated asset class. When we think about agriculture in particular, and I’ll start with just a focus on farmland, that’s even more true there. I mean if you look globally at farmland, estimates vary about around 1% institutional ownership. So it’s something that’s very lightly penetrated on the institutional side. It’s mostly still in private farmer hands. So by and large it is still an underpenetrated asset class with, we think, some attractive long term upside. Now, that’s not true in every single region. You really need to think of locally and globally. When you’re thinking about agriculture there are markets that we feel have gotten a little fully priced, but there are other markets that are still quite attractive. So it really depends on the particular market you’re talking about.
Gillian: Great. And we’ll have to drill down into some of those markets that you like best in a little bit. So I’d like to move over into talking about scenarios. One thing when I spoke with each of you individually before this was how you position in various growth and inflation scenarios. So, Mark, coming back to you, elephant in the room, we have a big election coming up in the United States, two candidates with potentially very different policy goals. Talk to me about some of the potential growth and inflation scenarios you see in the pipeline depending on which candidate comes in and how you will position against them.
Mark G. Roberts: Yeah. It’s always … it can be a challenge to determine based upon where we are in the election cycle today to really understand what’s going to be happening in the future. But I think it’s important for investors to lay out some of those scenarios. And you know it’s debatable but you could argue that in some of the policies talked about by one candidate, that there could be a lot more growth. But there could be much more volatile growth that’s associated with that, given some of the policy shifts that will be going on. You could argue that another candidate is thinking much more about sort of maintaining where we are with stable growth, a little bit lower growth than what could be a potential. That environment might be a lower inflation environment; the growth environment may be higher inflation environment, so. And there are a lot of range of outcomes that could come with these things and how many policies or laws will be changed. But I think what’s important for investors to know is when you look at these asset classes, they do perform differently in different economic environments. And so if you’re mindful of what some of those policies are you have the flexibility to shift into various asset classes or sub asset classes. So for example we’ve looked at the performance of many of these real assets, whether it’s infrastructure securities or RIETs, commodities, TIPS, timber and ag, and they perform differently in some of these different cycles.
So if you look at, just breaking it down to four different quadrants, rising or falling GDP growth or rising and falling inflation, you can see different leaders and laggers amongst each of those different sectors. I would say that, just to be frank about it, sort of the worst environment for some of these asset classes on an absolute total return basis would be in declining growth and declining inflation environment. But that being said, even when you’re at that level, things like TIPS, REITs, infrastructure securities all tend to outperform the global equity markets in that environment. So even in that environment we’d argue for having a strategic allocation. At the opposite end of the spectrum we have a rising growth environment or rising inflationary environment, that’s a great environment for real assets in general. But more importantly you see historically when we’ve looked at those conditions, what are the returns that have been generated, in materials you get an 11 or 12% return, in listed infrastructure securities or real estate securities you get between 9 to 11% return. That’s an environment where, despite sort of rising inflation, you actually want to underweight TIPS because of the nature of the cash flows that underpin some of these of things. Frankly, some of these asset classes are included in the CPI. So there is a good correlation to inflation. So I think the point with any of these political scenarios, to sort of step back, rationally consider what policies may be implemented and then look in how you can customize your portfolio to maximize your opportunities there.
Gillian: The quadrants are helpful when you think about it. So, Maxwell, building on this discussion is there any one particular scenario that you’re particularly focused on positioning against right now and how are you thinking about it?
Maxwell Gold: So you definitely have to jump off the points that we’ve just said. We do see that any potential short to medium term inflation risks are to the upside, that we are seeing continued inflationary pressures build based on potential fiscal policies. I think the consensus is we’ve had about eight or nine years of continued monetary stimulus, continued accommodative policies. And that really hasn’t put inflation pressured to where we would expect them. And so that’s resulted in very slow tepid growth, not just in the US but globally. And I think that the most logical next step is to move to more of a fiscal stimulus. And we actually do expect continued infrastructure spending as well as other fiscal policies to help stimulate growth globally. And we do see that as a benefit towards inflationary pressures which in particular for real assets, commodities, precious metals, should be a continued boon. And we do see that as sort of a scenario where we do see continued positive but weak growth in developed markets, and really looking more towards emerging markets as a continued growth engine of the global economy. But yet, where we do ourselves currently today is it’s sort of a bit of a stagnating environment where we’re not seeing much inflation compared to 2% targets that central banks like The Fed have iterated, and we’re still seeing continued slow growth. So we do see that potential fiscal policy stepping into in particularly the US economy. And we do see that as benefitting demand for commodities, demand for real assets, input of infrastructure spending, capital expenditure, that should be a boon more towards the entire real asset class.
Gillian: And some of the impetus behind that demand is something that I want to talk about in a little bit. Vince is there a reflationary surprise, coming.
Vince Childers: So I think actually we can tie together both of these themes, sort of the election cycle as well as kind of where we are in the inflation cycle. I think by looking and saying first and foremost, we appear to be experiencing kind of a populous revival. There’s a demand that something be done. And I think to Max’s point, fiscal stimulus is likely something that is going to be on the way, not just in the US but in a lot of the developed world who are facing some of these pressures of slow growth. Now, I think in terms of inflation the inevitable side effect of the disinflation surprises I talked about earlier are how they ultimately affect expectations for the future. And so for a number of years we were getting disinflation surprises realized. But if we looked at something like longer term forward inflation expectations, they were made relatively well anchored, in the neighborhood of The Fed’s kind of 2%-2½% CPI target. That really came to an end in really late 2014 and 2015 where we saw longer term inflation expectations start to become unanchored and start to fall quite a bit. I think what that tells me more than anything else is that a lot of the bad news from the disinflation scenario is now actually baked in the price. It is in the expectations. And so when we start thinking about how say, an infrastructure spending revival could potentially help to generate a reflation scenario, I think we’re at the point where we don’t feel like we need to imagine a 70s style inflation shock or an inflation problem to get real assets off the ground and performing, you know, sort of the idea of near normalization at this point given where expectations are, may be sufficient to give a lot of these assets a boost, and importantly actually get realized inflation to end up surprising on the upside.
Gillian: John, last but not least, how are you thinking about this in terms of agriculture?
John Goodreds: One of the key things about agriculture is … and it’s not that economic cycles aren’t important, they are. But I think what’s even more fundamental or more critical are the fundamentals. I mean we’ve got a global population of 7.2 billion, by most estimates that’s expected to growth to 9-9½ billion by 2050, with food demand expected to increase by 50-60%. When you think about those very powerful fundamentals that’s what’s really driving a lot of the opportunities in the ag space, it’s very fundamental factors. I mean people have to eat regardless of economic cycles. And economic cycles differ in different parts of the world. You’ve got areas of the world with exploding populations, of growing middle class, increasing food demand. So the ag sector is really driven much more by fundamentals than by economic cycles. So that’s one of the things we keep our eyes on.
Gillian: So I’m actually going to stay with you here, and you’re transitioning well. So we’re going to move from looking at the global macro picture to really drilling down into areas of expertise and where the opportunities are. So, John, what agricultural sectors or global regions do you find most attractive right now and why?
John Goodreds: We really think on a global basis in the ag sectors and there’s a few reasons for that. I mean there are some particular risks to investing in agriculture that we think are best diversified by a global portfolio. So what we like to do is think about diversifying within particular countries, continents and even hemispheres. So for example we’re large investors in US farmland, but not all sectors within the US have been equally attractive, for example, the US Midwest, we’ve bought very few farms there in the last couple of years. Now, it’s arguably some of the best farm ground in the world, but we thought the prices got a little ahead of themselves so we backed off a little bit. But we’ve seen good opportunities in the southeast, the delta, Pacific Northwest, the west coast; in addition we’re active investors in Australia, Brazil and a few other select companies. So by having that globally diversified portfolio I think there’s quite a few risks you can begin to mitigate, including pricing risk in particular markets.
Gillian: And, Mark, talk to me about your global positioning right now?
Mark G. Roberts: Looking at each of the asset classes we’re more of an overweight position to say real estate and infrastructure and a bit of an underweight to commodities. And we’re seeing it as the days go by here, the dollar is strengthening again today, that’s having some knocked on effects to oil prices, at the same time when the dollar expectations of maybe The Fed raising interest rates, that’s increasing the dollar. So that maybe reduces the demand for gold. So from an asset class perspective you look at where the valuations are and where the growth expectations are for each of those, for listed infrastructure or non-listed for real estate, both listed and non-listed. You can capture dividend yields in the range of 3½-4½% on average. There is reasonable estimates of growth of anywhere from 3-5% earnings growth. It’s interesting to note in listed infrastructure securities, that EBITDA growth has averaged about 5½-6% over the last 20 years. The worst that it ever got was in 2009 at 4% positive when the equity markets are bouncing around. So it’s fairly easy to get to for unleveraged assets sort of that 7-8% range and modest amounts of leverage can add to you more. So that’s where some of the growth is. Looking at where some of the world’s growth, maybe on a strategic perspective, there’s population growth in the US to some degree. It’s reasonably flat in Europe and a lot of growth in Asia. So from a structural perspective I think taking a look at those markets are important. And then finally one thing that is in the election as I think was mentioned, is just this need for infrastructure investing. That’s something both candidates agree upon. And I know we may talk about it a little bit more but that’s an area where there’s some potential for growth.
Gillian: Absolutely. And I’d love to come back to that. Vince, what are the opportunities you’re seeing right now?
Vince Childers: So I think in order to make sense of it I think a little bit of context. So by the end of last year, end of 2015, we had spent the better part of the last several years’ underweight commodities. With concerns around really a sluggish demand, global demand environment running kind of headlong into years of investment spending, CAPEX spending actually bringing a lot of supply on in the commodity complex. And so you had kind of the worst of all possible outcomes, sort of a sluggish demand meeting ample supply. And so you saw, you know, commodities get hurt very, very badly, really from kind of 2011 through 2015. Earlier this year we started to kind of nibble at the commodity complex. That started for us with focusing more on the resource equities, the view being that while the commodities themselves being kind of functions of the here and now supply and demand, might struggle to generate a strong total return, the equities could be more forward looking, could sort of discount a whole futures scenario or set of scenarios for supply and demand and that we might see the resource equities move first. And in fact that has been what we’ve seen. So we’re moving, I think and a very big picture way is kind of taking small and measured steps away from some of the more rate sensitive parts of our portfolio, you know, to some extent that means REITs and parts of the infrastructure universe.
And moving more toward the commodity complex, but again sort of the measured pace I think has been key to the way we’ve seen this. Ultimately we think that we’ve gotten to the point where spot prices let’s say across a lot of the commodities have gotten low enough where you’re destroying supply. And you’re sort of getting the cycle to correct itself. And the aftermath of these types of events typically, this is what sets the stage for future bull markets. But it often takes a lot of time. And so we’ve sort of said, “Hey, we’re not going to be in a huge hurry here.” But the direction is more toward the commodity complex.
Gillian: So positive expectation but measured pace moving there.
Vince Childers: Measured pace, that’s right.
Gillian: Okay. Maxwell, I want to talk to you about both gold and other precious metals, but I want to separate them briefly. Let’s start with gold; we saw a huge flight to safety, especially in the wake of things like Brexit, a lot of interest and a rally in gold. Talk to us about your outlook specifically there for the rest of the year.
Maxwell Gold: So our outlook is still constructive on gold. You know, gold is very unique, it’s a very polarizing asset, everyone has a view, whether it be positive or negative. But overall, you know, we view our outlook for gold still constructive based on just a complete reversal of investor sentiment which has been the driving force of performance so far this year. Overall we’ve seen about 560 metric tons added to ETFs globally in gold, physically about gold ETFs, which to put in context, we haven’t seen an inflow that big since 2009. So you know really there’s been a fundamental shift in terms of how investors view gold in particular as well as in the context of other investment alternatives. And really, you know, what we see that is, you know, we started off the year following The Fed hike in December of 2015 with negative net sentiment towards gold. We’ve actually not just seen a reversal but a record high level of positioning in terms of sentiment by investors about gold. So there’s just been a complete reversal in terms of positioning, sentiment, flows and performance. Obviously it’s a very strong performer, up 25% this year. And overall, you know, we do see a continued, you know, outlook that is, you know, it’s still beneficial based on real interest rates. You know, we see that as one of the key drivers for gold that which has a very negative correlation to real rates.
So that we do see that, you know, gold will continue to perform as we do see lower for longer interest rates persist in the US as well as other developed markets such as Europe and Japan, particularly in an environment where we do see, you know, potential inflationary pressures begin to perk up. You know, especially as we do see more infrastructure spending, fiscal policy spending and really more of consumer driven inflationary pressures begin to manifest. That, you know, in our perspective, you know, views gold as a good alternative particularly in a negative real interest rate environment. And so far this year we’ve actually seen rates on a nominal basis move into negative territory. So it’s very challenging for investors to really, where do they decide to put their liquidity, their additional capital, but not just that, but you know, really from a diversification or a risk hedging standpoint, gold is very good from that.
Gillian: So there’s been a lot of spotlight on gold but it’s not actually the year’s best performer in this space, is it? Which one is it and what other opportunities do we see?
Maxwell Gold: So actually silver’s been the top performer so far this year. Silver’s fortunes are a bit tied to gold; it does have a very high correlation, about 80%, but silver’s up about 38/40% so far this year. And what’s not realized is that silver along with most other precious metals, they do have a cyclical and non-cyclical component. And we do see that silver’s cyclical component in particular, industrial demand has been beginning to pick up as we’ve seen, because continued silver imports into key markets such as India, and really a strong continued fundamental demand from that perspective. On the flipside we have seen sort of a similar trend from investor sentiment as we’ve seen for gold so far this year. We have seen continued inflows to silver ETFs which are actually currently at record all time highs, as well as a reversal of sentiment in futures positioning. And that’s been an additional boon for silver’s performance so far this year. And we do expect that to continue but additionally we do see that silver’s much more tied to the industrial production cycle. And we’ve seen a bit of a stagnation, depending on what market you’re looking at, in particular the US on a global basis, but overall as we do see the global economy continue to recover, we should see silver continue to increase demand for key markets such as solar panels. You know, I think that we’re seeing continued growing demand in China for installation of solar panels as renewable energy becomes more and more a focus for governments globally, you know, as a key component. So there’s other industries outside of just pure investment and what’s happening with The Fed or other macro factors that are driving these particular markets on a fundamental basis.
Gillian: So the gold and silver rush not over yet, that’s for sure.
Maxwell Gold: Right.
Gillian: Okay. I’m going to bring us all back together for a moment, obviously adjust to each one of your areas of expertise. Let’s talk about risks, Mark, starting with you, what are the risks you’re most focused on right now?
Mark G. Roberts: Well, certainly the whole interest rate risk is one that we’ve talked about that’s going on. You know, in the real estate market there are pockets of risk here and there, driven either by supply or what’s taken place. So for example, you look at Brexit and what happened there. Already leading up to Brexit there was a lot of new construction going on in the London office market. And you know it was our view even before Brexit that the relative value was greater going elsewhere on the continent. And certainly the capital values there are maybe down 5-7%, we think there’s a risk that they could go lower. Now, offsetting that is now the pound trading at 30, you know, at historic lows. So on the one hand the fundamentals, it looks like it’s going to be a little bit challenging there. But given the depression in the British pound, it could provide a good entry point. And I would say that there are other things on the margin when you look at other places and other sectors. Washington DC, we’re waiting for it to sort of come back in the property markets there. It’s one that was a very safe haven type of market coming out of the credit crisis, because they had a lot of capital flowed in, new construction picked up. And it’s really been a laggard among some of the property sectors. I would say maybe more of a longer term risk in infrastructure, what it’s doing right now, right now are cell towers and telecommunications, just because of the growth in data and demand and bandwidth.
But I think one thing investors need to be mindful of in that is the substitution that came in with sort of local towers and things like that that could create some competitive aspects to it. And then there’s just this disintermediation going on because of ecommerce. So the bricks and mortar, you’re seeing it in Manhattan where you have a lot of flagship stores and high street retail does well. But then you have fulfillment centers and procurement. So it’s really supporting the demand, for warehouse property it’s sort of at the expense of some of the bricks and mortar stores. But the point is there is a lot of different optionality in terms of what you can overweight and underweight in each of these asset classes.
Gillian: Got it, and we’ll definitely be touching more on that. John, in agriculture what are you seeing, what are some of the risks?
John Goodreds: Interestingly in agriculture, if we take farmland for example, traditionally it’s had a fairly high correlation with inflation as you might guess because food is a component of how you measure inflation, so there is an obvious link there. So it’s less economic cycles and interest rates and inflation and it’s more how to construct robust portfolios on an asset by asset basis. So when you think about farmland for example, one of the risks that would come to mind would be water for example. And we do buy land in California, so we’ll use that as an example. So when we look at farm ground there, we’re very thoughtful about identifying two sources of water for each farm. It’s tempting, I mean there are parcels out there that look attractive but there’s real water risk. So we tend toward the Cadillac of those kind of properties with two water sources, and we think robust ongoing operations. And in addition to farmland we’re actually also seeing a lot of opportunities in what I would call the ag value chain. So if you think of farmland, that’s one component of the broader ag cycle. But there’s all kinds of companies out there, agri business companies that supply inputs or perform processing or protein production and by and large those companies are driven less by commodity cycles and commodity prices and more by the volume requirements of a growing demand globally for food.
So we, on that side of the business look very carefully at the quality of management teams in which we’re investing, the outlook for the particular commodities or foodstuff that they’re processing, opportunities for export because we tend to focus on investing in developed countries that are exporting to developing countries. We like that risk tradeoff, where we want the upside potential of developing nations growing food demand but we like to invest in the safety of developed markets. So those are a few of the risk areas we think about.
Gillian: And one other that I want to touch on with you, how do you address the growing institutional investor concern about sustainability in ESG investing?
John Goodreds: Excellent question. And one thing I would say about all real assets but ag in particular is it’s a long term asset class. When we invest in this sector it’s with 10, 15, even 20 year whole periods in mind. So when you think about sustainability, if we’re going to own an asset for that long it just makes economic sense to manage it in the most sustainable basis you can, otherwise you’re potentially impairing the value of your own asset. And increasingly investors are asking, you’re absolutely right, more and more questions around sustainability and ESG. And what we’re finding is more and more third party certifications and third party governance bodies being more and more a part of the real asset class. So for example, in agriculture we’re a signatory to the United Nations Principle for Responsible Investing in farmland, now called the PRI Farmland Guidelines. And those are publicly disclosed guidelines which we follow and publish and report on. They help us through the diligence period, through the management period and even through the sale period and how you sustainably manage and follow ESG guidelines in farmland. So it’s something that’s very central to the way we’re thinking about the real asset space in general.
Gillian: Got it. Vince, some of the risks?
Vince Childers: So I think I always have my risk management hat on, there’s always something I’m worried about. I think one of the things that continues to keep us up and keep us focused is, and I guess we had a preview of this earlier this year is when the market reacts to an assessment that the central banks around the world, The Fed in particular may be embarking on a policy or sort of a growth destroying inflation crushing kind of policy area. We’ve seen this happen over the last several years, we know that the market is pricing very little in the way of rate rises for multiple years out. This is it seems to be at odds with some of the expectations and some of the language that comes out of The Fed. And so when we had these periods where it seems like market expectations are misaligned with central bank policy, and we’re living in a world where central bank action appears to have had a lot to do with influencing asset price moves, the concern that a misstep is made in terms of what I would characterize as a hawkish kind of policy area, that the market is simply not pricing assets for and not anticipating. I think that presents a risk, clearly not just to real assets, but to risk assets more broadly. So it’s one of these things, it’s very tough to get right in terms of base case expectations. And so we try to focus a little bit more on the risk management side of the equation when it comes to some of these sorts of unknowns.
Gillian: Okay. Maxwell, what about you, what are some of the risks you’re thinking about in the precious metals space?
Maxwell Gold: So definitely I think a lot of it echoes on what’s been said here already. But in particular sort of the great experiment of quantitative easing or actions by central banks has sort of had twofold. One is that it’s increased liquidity and it’s increased confidence. And there’s just so much liquidity chasing, so few assets out there. And, I think that our question is here what is the longer term implications of such policies, particularly with the expectation that policies will continue to go longer than expected. And really our view is that that potentially could be a boon or it could be a risk to particular precious metals. For example, we do see, looking at The Fed, any particular risk is if they become more proactive instead of their reactive stance which currently they’re very reactive to inflationary pressures. That’s been the one thing they keep echoing, in their view is the labor markets are very strong, but really what the focus should be is inflation. And they’ve reiterated that they’re remaining data dependent. Now, if they were to flip that stance and say it’s similar to a tightening cycle such as 1994, where they had successive interest rate hikes very quickly to try to combat inflationary pressures. If they take a more proactive stance like that, currently I think that’s a risk towards real assets, in particular gold and silver which do tend to be much more correlated with real interest rates and overall monetary policy.
Gillian: You just touched on liquidity and I want to direct this to you, Mark. Talk to us a little bit about how you look at liquidity in infrastructure and real estate. Have you seen any changes and how do you think about it when you explain it to your investors?
Mark G. Roberts: Well, when we work with investors in developing a portfolio, that’s obviously one of the key questions is how much control do they want, how much liquidity do they need, their ability to rebalance and so on. And there are there are different degrees of liquidity, ranging from TIPS which are going to be very highly liquid to something like a very large direct infrastructure deal which is going to be less liquid. So I think that’s a point of some of these, that there is a range of liquidity that can be achieved really across the spectrum. And those things are, you know, I would look at some of those today and currently when you have something that may be has more liquidity to it, it can be have higher volatility, so it can sort of change some of the performance attributes of what you might want in the portfolio. I would say one thing that we’ve tried to do in helping to develop and understanding this asset class is there really hasn’t been a listed infrastructure debt index before. And so it [inaudible] in cooperation with a third party [inaudible] market, launched the listed infrastructure debt indices.
Now, these are indices that were extracted from corporate bond indices, so investors have already been investing in them. And you’d be surprised to know that for equivalent duration these sort of pure play companies that underline some of this debt have lower default rates for equivalent rated bonds. They have higher loss recovery rates, maybe this is reporting back to 1983, loss of recoveries, like 75% versus sort of corporate bonds which is maybe 50%. In addition they have higher total returns over the last eight years that are beating the corporate bond market and global bond market as well as global equities. So those are going to be more signals and tools that can help investors. This has clearly got liquidity, these are publicly traded. And I think it’s going to help inform investors better about how to underwrite some of the risks in these asset classes.
Gillian: So an interesting innovation there. Vince, broadly how do you think about liquidity here?
Vince Childers: Well, for us it’s pretty straightforward. So at Cohen & Steers we are focused on listed exchange traded highly liquid real assets. So for us the focus is more on treating this as a global opportunity set, realizing that we have global opportunities in real estate, in infrastructure, in commodities and in producers of those commodities, the resource equities. And so liquidity very broadly we think is an important part of any real assets allocations. I think importantly we do not think of sort of listed liquid real assets as somehow in competition with more direct illiquid holdings. And we think that they serve as compliments to one another, but that most investors should be able to benefit from having some portion of their broader real assets allocation really in kind of liquid, core, global real assets.
Gillian: Do you agree?
Maxwell Gold: Absolutely. I mean in our case we focus primarily in the precious metals space and offering through the ETF wrapper, so physically backed products. And really what we view that as is these markets are actually very deep and liquid, much more in par with other financial assets, other currencies. And so we do see the benefit of the diversification benefits of these types of assets in the fact that they are very liquid by their nature. So it’s a little bit of a less of a concern for us, but we do see the importance, and growing importance of liquidity, particularly as we’re seeing continued focus on bond markets and other less liquid securities out there, that it’s becoming more of a concern for a lot of investors.
Gillian: John, when you’re thinking about farmland, how do you think about liquidity?
John Goodreds: So farmland is interesting, broadly speaking in real assets, and we certainly agree that I think most investor portfolios could benefit from a balance of both liquid and illiquid offerings in farmland in particular. That is a longer term asset class. And our view, it’s better held in a private unregistered vehicle. But that’s our view, I know there are some public options out there. Ultimately it really comes down to I think, careful analysis on each investor’s ability to hold long term illiquid asset classes. When we look at farmland for example, when we look at long term cycles, they perform very well. It doesn’t mean prices go up every year, I mean no asset does. But over long periods of time if you’re willing to take that 10 year plus viewpoint, farmland for example, we think is a very attractive asset held in the right vehicle.
Gillian: And you spoke a little bit about the agricultural value add diversification in a portfolio, could that potentially alleviate any liquidity concerns or do they tend to be illiquid as well?
John Goodreds: Well, so that’s an interesting question because there are different ways to get exposure there. I mean there’s certainly publicly traded agri business companies, but they tend to be fewer in number than in the privately held sector. Like what we’ve seen for example is that many agri businesses are still family owned. And they’re in need of capital because you think of the volume of food that’s being produced today and where the growth needs to happen, many see the growth opportunities and they need growth capital. And they don’t necessarily want to go public, and they don’t necessarily want to go through a full sale to a financial buyer or a strategic buyer. So the ability to provide either equity or structured equity or debt to these type of companies in the private markets we think is the bigger opportunity. So there are opportunities in the public market. But we think the bigger opportunity is in the private market.
Gillian: Got it. Vince, moving over to how these assets fit into a larger portfolio, talk to me a little bit about diversification within real assets and then how they fit into a larger portfolio.
Vince Childers: Sure. So I think one thing we see and I mentioned this earlier on is that if there’s a kind of common factor that makes real assets an asset class it is this more positive sensitivity to inflation surprise, whereas what we see typically with stocks and bonds, like high quality duration treasury bonds or something of the sort, negative inflation sensitivity. So one of your biggest kind of diversification benefits versus stocks and bonds comes from that differential inflation sensitivity. But when we look into the core of real assets we see that they’re not really on average particularly well correlated with each other. There’s a lot of ability to sort of treat this as an asset class and harvest the diversification benefits within and across the real assets. So an example would be, do we think that a real estate cycle would have any particular reason to be well correlated with a crop cycle, right. When the inflation move let’s say is not the dominant factor then you get a lot of this kind of more asset class specific, these asset class specific drivers of risk and return. And so our view is that, well, there are a lot of tradeoffs you face as a real asset investor, how do you balance expected return with diversification potential more broadly with inflation sensitivity. And our perspective has been, well, there’s no one category of real assets that solves particularly across all of those dimensions. When we start putting this together as an asset class we have historically seen good outcomes across them. Now, when you expand it to the broader portfolio, I think first things first, we’re not the people who sort of show up and say, “Hey, back up the truck and put everything into real assets.” We do think about this as an asset class that is meant to improve overall portfolio efficiency, right. And so what we see with real assets historically over the last, you know, 20/25 years and beyond is that the addition of a diversified portfolio of real assets to say a kind of balanced moderate risk stock bond portfolio, tends to preserve return, but reduce volatility, reduce risk and thereby increase risk adjusted return or sharp ratios. And so to us, you know, in modest amounts, depending on the investor whose liquidity and investment horizon has to be respected, something like, you know, 10 to even 20% of the broader portfolio could be again in a diversified real assets allocation, but importantly not just one category over another.
Gillian: Okay. And, Mark, talk to me a little bit about how you think about diversification within real assets.
Mark G. Roberts: We’ve had some fun sort of back testing some of these things. And there are a couple of barbells on the spectrum here. You could look at these asset classes, say take 30% real estate, 30% infrastructure, 30% commodities and 10% TIPS and if you look at that historical performance what you’d find is that it can be complementary to say global equities. You’d have a reasonably high correlation to global equities, but you’d have higher total returns and a better risk adjusted return in global equities. So in that case it could serve as a substitute. But what contributes to that is sort of the volatility that we’ve seen in commodities. So if you sort of start with an anchor that has say 60-70% of the portfolio in real estate and infrastructure, and then if you have tactically a growth bucket that might consist of energy and natural resources, and then say an inflation hedging bucket that might consist of precious metals, gold, TIPS, floating rate net notes on sort of the inflation side. It’s not too difficult to sort of look at, okay, are we really in a growth environment or are we in an inflation environment? And be able to tilt that portfolio one way or the other, and sort of have an anchor in the middle. When you do that, you know, that lines up well between sort of stocks and bonds and it really sort of pushes out the efficient frontier. There’s much lower correlation then you get much better diversification. You know, assuming that you’ve got some reasonable active management with sort of a tactical view and maybe some concentration within the individual stock selection in some of those, that offers you the chance of getting better performance. So you know, it’s flexible to decide what it is but I think it’s important to understand what are the performance attributes underlying that when you’re designing that portfolio.<ADD SUPER WITH THIS DISCLOSURE: Backtested performance is not an indicator of future actual results. The results reflect performance of a strategy not offered to investors and do not represent returns that any investor actually attained.
Gillian: Sure. John, how does agriculture fit into both institutional and individual portfolios?
John Goodreds: It sounds like we’ve all done some similar studies over time. For example one of the things we’ve looked at is if you take the traditional public equity, public fixed income portfolio and add real estate to it, higher risk adjusted returns. The same is true for farmland, the same is true for timber. Interestingly, if we take all three it’s higher risk adjusted returns than just adding any individual. So we think there’s a lot of real asset categories that work quite well together. Now, within farmland it’s a surprisingly big sector. There’s a lot of ways to diversify within farmland. And I’ll use an example from the real estate sector which I think most investors are more familiar with. Many investors have a core real estate program and a value add real estate program. You can think of farmland, I think, in a similar manner. So farmland for example you can think about real crops, so think about corn and wheat and soya beans. You can kind of envision what I’m talking about. That tends to be a core farmland strategy. Then you can start adding things to it like permanent crops, higher risk but higher potential return. And those are things like trees and vines, apples, grapes, tree nuts etc. So that’s one way to think about it. Another way is to think about diversifying geographically, that can add quite a bit to the diversity. And then on the value add side adding agri businesses that supply and puts the farmland, and that process the food coming off the farmland, where that would involve the protein production, that’s more of a private equity style higher risk, higher potential return strategy. But that’s another way to diversify an agriculture portfolio.
Gillian: And lastly, how do you think about putting real assets into a larger portfolio?
Maxwell Gold: So we’ve given this a lot of thought. We explored the diversification benefits and the real risk management benefits, particularly precious metals. In today’s environment I think the scarcest commodity is true diversification. We’re seeing traditional relations between equities and bonds begin to break down in periods. And we do see the diversification benefits, in particularly for precious metals stemming from its low correlation to equity risk, driven by fundamentals of both cyclical and non-cyclical demand. And really where we do see that is in an environment where post financial crisis, diversification is becoming much more difficult to achieve. We do see that precious metals can offer sort of that true diversification by offering portfolio efficiency. So obviously increasing expected return and reducing volatility at the same time, but thereby increasing sharp ratios. But overall we do see, you know, the question is, so what is the optimum allocation for a diversified portfolio to say, example, precious metals. I think the answer is we do see the optimum allocation as just being non-zero. Obviously depending on risk profiles for clients, we do see different potential options, but we do see the strategic benefits of having some dedicated allocation in particular to precious metals, which we are seeing a distinction between even other commodities which tend to be much more highly cyclical to the overall market environment, as well as equity risks. So precious metals we view them as a separate asset class unto themselves and you know, getting true diversification benefits in an environment where diversification is becoming much more difficult to achieve.
Gillian: Got it. I can’t believe that we’re already coming to the end of our discussion. So I’m going to give each of you an opportunity to just give 30 seconds final thoughts, what you think someone who’s interested in real assets should take away from this. Mark, I’ll start with you.
Mark G. Roberts: Well, I would start with saying, look, global real estate securities has sort of led the way and created an appreciation for being able to invest globally and it made it easy to do. You’re beginning to see that happen more so in the non-listed core real estate space as well where investors are trading off maybe some of the volatility and approaching it with core investments and having lower leverage and getting that, sort of that [inaudible] investment. So I think that is continuing to take place and will continue to evolve. There are other vehicles that are out there for investors to consider, non-listed REITs are another example. And that could have an expanding marketplace as well. So I think the vehicles are there and some of the transparency is there. And today fortunately I think from a valuation perspective if investors take a disciplined look there’s some good value that’s out there today.
Gillian: Great. John.
John Goodreds: I think agriculture as an asset class is probably where real estate was 20-30 years ago in terms of investors understanding and interest in this sector. And I think the reason we’re seeing more and more investors interested in this sector is a combination of positive correlation with inflation being driven by fundamentals. And that combination of a bond like an equity like security and that bond like because you own a physical asset, that can provide current income, but equity like because of long term appreciation of that underlying asset. So I think you’re going to see more and more investors interested in this sector.
Gillian: Great. Vince.
Vince Childers: Yeah. So I guess I’ll reiterate something I hinted at a little bit earlier. And I think this is important. A lot of investors I think are sniffing around real assets right now, sensing a value opportunity, sensing a good entry point. But my concern or my worry is that they’re thinking about the asset class as a trade. One of the messages we have tried to drive home is that this is a strategic asset class, something that investors should embrace and stay allocated to, right. Now, almost all investors are going to do some degree of kind of dynamic asset allocation through a cycle. But the argument we’ve tried to make is that holding some kind of core real assets allocation in the broader portfolio has a long history of demonstrated value add. And that we think investors are going to get the best outcomes when they’re thinking about this again with their asset allocator hat on as opposed to their trading hat on.
Gillian: Got it, so a long term play, Maxwell, you.
Maxwell Gold: So I think here definitely the key takeaway is in an environment where we’re expecting continued episodic volatility, a lot of illiquidity driven by central bank accommodative policies, we do see continued investors to look to sort of that alternative or what is the alternative. And we do see the risk management benefits of precious metals in particular to diversified portfolios. We do see them, view them first and foremost as core risk management tools, both from a tail risk hedging perspective, they’re great when we do have a lot of volatility in large equity drawdowns as well as from a diversification or equity factor risk as well as a hedge against potential inflationary pressures which given the amount of quantitative easing that we’ve seen so far this year, as well as in recent years, we do expect that to continue to bid up potential inflationary pressures in addition to potential fiscal policies.
Gillian: Thank you so much, we have run out of time so I appreciate you taking the time to tell us a little bit more about real assets and how they fit into a broader portfolio. Thank you so much for tuning…
The opinions and forecasts expressed herein are those of the speakers and do not necessarily reflect those of Deutsche Asset Management, are as of October 4, 2016 and may not come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security.
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