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CEF Insights: Real Assets - Predictable Cash Flows in Volatile Markets

Larry Antonatos
Larry Antonatos, Portfolio Manager & Head of Real Asset Solutions with Brookfield, and the Closed-End Fund Association discuss the outlook and opportunities for allocations to real asset sectors in a portfolio. 





Welcome to CEF Insights, your source for closed-end fund information and education, brought to you by the Closed-End Fund Association. My name is Diane Merritt. Today we are joined by Larry Antonatos, Portfolio Manager and Head of the Real Asset Solutions Team with Brookfield Public Securities Group. We're happy to have you with us today, Larry.


I'm happy to be here, Diane. Thank you.


Larry, can you discuss the characteristics of real assets and how they may benefit investors?


Real assets are investible assets that are physical in nature rather than financial or intellectual. The three major types of real assets are real estate, infrastructure, and natural resources. Real estate is the most well understood and most widely held of the real assets. Real estate value is generally derived from rental income based on lease agreements. Real estate is a free market, competitive industry with many landlords and many tenants. Like most industries, the intersection of supply and demand determines price, in this case, rental rates. Supply is driven by cycles of new construction, demand is driven by cycles of economic activity, and these cycles can cause market rental rates to move up and down. However, property cash flows and property values tend to be steadier than market rental rates due to the long-term nature of leases. Most commercial property is governed by leases of five years to 10 years.

The second major type of real assets is infrastructure, and infrastructure is a terrific complement to real estate. And we see the level of interest in infrastructure growing rapidly. Infrastructure value is generally derived from fees charged to provide infrastructure services. Infrastructure has interesting characteristics of supply, demand, and pricing that are different from real estate. First, the supply of infrastructure assets is frequently regulated and many infrastructure assets are monopolies or semi monopolies such as the only electric utility or water utility or airport serving a city or geographic area. Second demand for infrastructure services is generally steady because these services are generally essential services such as power, water, and communication.

A fourth area of infrastructure, transportation, which includes airports, seaports and toll roads, is subject to traffic fluctuations and economic sensitivity. The pricing for infrastructure services is frequently regulated because they are essential services. Because of the supply, demand and pricing characteristics, infrastructure can provide very predictable cash flows and values.

Natural resources are the third major class of real assets. Natural resources value is generally derived from spot prices of commodities, including agriculture, energy, metals, and mining commodities. Supply is generally increasing due to technological improvements over time, and demand is generally cyclical based on economic activity. Accordingly, cash flows and values of natural resources can be volatile. Real assets can provide four important investment benefits, current income, long-term capital appreciation, inflation protection, and from a total portfolio perspective, attractive correlations, relative to traditional equities and fixed income. 


Your team manages closed-end funds and other products that invest in real assets securities. What sectors do you consider for your portfolio of real asset securities?


First, we consider corporate bonds of public real estate, infrastructure, and natural resource companies. Secondly, we also invest in mortgage backed securities, both residential mortgages and commercial mortgage backed securities. And third, we look at the equity of public real estate and infrastructure companies. We generally avoid natural resources equity due to the high volatility that I described a moment ago.


The economy and markets have gone through significant shifts since mid-February. How have these challenges impacted the various segments of real assets?

Larry: As you might expect, infrastructure has been the steadiest performer due to its essential services profile. Within infrastructure, communications has been the strongest performer as the economy has shifted to work from home. In contrast, transportation sectors have been the weakest with particular weakness in airports as travel has declined dramatically due to shelter in place. Real estate has been more volatile than infrastructure. Within real estate, data centers have been strong, again, due to work from home, while hotels and retail have been weak due to shelter in place. Natural resources has been the most volatile real asset sector as the global economy has entered a recession and demand for many commodities has declined dramatically.

CEFA: How active are you in allocating among these sectors and what goals and/or risks are you trying to address as you modify those allocations?


Our asset allocation goal is to attempt to improve risk adjusted performance, considering both return and volatility. Our asset allocation changes are driven by both the top-down macroeconomic view and a bottom-up sector valuation view. Top-down views may drive decisions to increase or decrease portfolio risk such as shifting between equities and fixed income or shifting between more defensive infrastructure equities and more cyclical real estate equities. Bottom-up sector evaluation views may drive decisions to rotate among cheaper and more expensive asset classes. With these top-down and bottom-up changes, we attempt to improve risk adjusted performance of our strategies.

CEFA: Are you finding valuations to be at attractive levels among these sectors?


After difficult performance in 2020 Q1, almost all real asset sectors are attractively priced. Energy infrastructure equities are extremely cheap, but they do face short term headwinds from weak energy demands. Real estate equities are also cheap by historical standards. However, the pace of reopening of the global economy is quite important to the sector, so there is some cash flow risk here. Broad infrastructure equities appear to be fairly valued with limited cash flow risk. Within infrastructure, there certainly do appear to be attractive opportunities within some of the more hard hit transportation sectors. Within fixed income, corporate bond spreads are wide indicating good value. Mortgage backed securities also have wide spreads and good value. Within mortgages, we see residential as lower risk relative to commercial mortgages.

CEFA: Where are you seeing the best opportunities?


Our top-down macroeconomic view is for a W-shaped recovery. Integrating that view with bottom-up sector valuations, we see real estate equities and corporate bonds as most attractive on a risk adjusted basis.

CEFA: Larry, the Federal Reserve and the federal government have initiated significant policy responses to the COVID-19 related downturn. Interest rates are low, US growth is uncertain in the near term, but hopefully begins to recover in the second half of the year, and headline inflation has not been significant for some time. How does all this position real asset investments in the current market and what is your outlook for 2020 and into 2021?  


Through 2021, we expect economic growth, interest rates and inflation to all remain low. In this environment, real estate and infrastructure should perform well due to the predictable cash flows driven by long-term leases for real estate and driven by essential services for infrastructure. We also think that the high levels of current income of real estate and infrastructure will be attractive relative to extremely low interest rates, driving interest and performance in those sectors. Beyond 2021, we expect economic growth, interest rates, and inflation to move higher. In this environment, we would actually emphasize the equity component of our portfolio, where the ability to grow cash flow is greatest, and perhaps the equities would perform better than the fixed income portions of the real asset space.


How do you see an allocation to real assets best positioned in an investor›s diversified portfolio?


Generally, I see portfolio allocations to real assets of 5% to 15%. Because real assets provide both income and capital appreciation, we generally see these real assets allocations funded from modest reductions in both equity allocations and fixed income allocations.

CEFA:  Larry, thank you so much for taking the time to join us today.  


Thank you, Diane.

CEFA:  And we want to thank you for tuning into another CEF Insights Podcast. For more educational content, please visit our website at  

Audio recorded 06/09/20.


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