Mike Pinggera, Head of Multi-Strategy at Sanlam Investments, provides an overview on real asset investments in a recessionary environment.
With the interest rate cycle appearing to peak and light visible at the end of the tunnel, the risk that central banks have gone too far and a recession ensues now becomes a factor to consider. Transition periods can be challenging for investors and understanding how real asset investments, in particular our focus areas of infrastructure, renewable energy, and specialist property, have historically fared during economic contractions can provide helpful insights for investors navigating the complexities of the market. From the outset of the Sanlam Real Assets Fund, our companies have been selected for their underlying resilience as well as their potential for long-term stable returns. While recognising the recent pressure on listed share prices (weakness not seen in private markets), these fundamental characteristics mean that these assets should not be overlooked as reliable havens during periods of financial uncertainty.
Infrastructure investments (36% portfolio weight), characterized by the development and ownership of assets providing essential public services, have often demonstrated resilience during economic downturns. Governments around the world recognize the role of infrastructure in stimulating economic growth and creating jobs, leading to increased investment in transportation, energy, and telecommunications networks. While some infrastructure projects may face delays or funding constraints during a recession, the overarching importance of these assets in supporting societal needs provides a buffer against economic volatility.
Renewable energy investments (32% portfolio weight), while promising for their sustainability and long-term environmental benefits, have faced varying degrees of impact during prior economic contractions. Historically, government support through subsidies and tax incentives has bolstered the development of renewable energy projects. And while there are near-term question marks regarding the financial viability of certain ventures, the stability of government policies, and the availability and cost of financing, it should be noted that corporate pull (rather than government push) is an increasingly supportive factor. With the global demand for sustainable energy sources and the increasing awareness of climate change, renewable energy investments are positioned as a significant component of the transition toward a greener economy, encouraging long-term investor confidence.
In the realm of specialist property investments (22% portfolio weight), the performance of housing, student accommodation, and logistics facilities during recessions has been influenced by the specific dynamics of each sector. Housing, being a fundamental necessity, often maintains a level of stability during economic contractions as the demand for affordable housing remains relatively constant. However, segments of the housing market tied to luxury properties (where we are not exposed) may experience a decline in demand, reflecting changes in consumer spending patterns and risk aversion. Student accommodation has historically been closely linked to the ebb and flow of enrolment in educational institutions, but at present demand is outstripping supply and the long-term demand for education continues to underpin the stability of this sector. Finally, logistics facilities, a crucial component of the evolving e-commerce landscape, have exhibited resilience during economic downturns as the growing demand for efficient supply chain management and last-mile delivery services sustains the sector's growth trajectory.
Analysing the cyclicality and inflation linkage of revenues in real asset investments is critical for understanding their performance dynamics during different economic phases. While these investments may demonstrate a lower degree of underlying cyclicality, their share price performance is often influenced by short-term economic trends and central bank policy. They also offer a hedge against inflationary pressures with many infrastructure projects and specialist property investments incorporating mechanisms such as inflation-linked tariffs and long-term lease agreements that adjust to changes in the overall price level, thereby protecting investors from the erosion of real returns.
Window of opportunity
The current interest rate cycle reaching its peak presents both opportunities and challenges, with the positives of the end of the tightening cycle potentially being offset by economies moving into recession. Listed real asset investments have shown an underlying resilience during the tightening cycle but share prices have not been immune from the impact of rising rates which has led dividend yields and the discount rates used in asset valuations to rise. The less cyclical nature of real asset investments means they are well positioned in the event of a recession and can be expected to be a significant beneficiary of lower interest rates should central banks adjust course. This environment will of course also be good for high-quality bonds, but were inflation to remain elevated at the same time (the dreaded stagflation), real assets would provide a better shelter for investors.
In the past week, we have seen news of Goldman Sachs raising $4bn for a new infrastructure-focused private equity fund, proclaiming in their announcement: “Investors are pouring money into everything from toll roads to power networks as they seek out assets that can deliver steady returns and guard against inflation”1. Not to be outdone, Blackstone have invested $5.4bn in infrastructure assets in 2023 to date2. It is clear that infrastructure, renewable energy, and specialist property investments, although influenced by the broader economic climate, continue to be sought after for their potential to deliver consistent returns and mitigate the risks associated with market fluctuations. The discounts and depressed share prices of listed companies looks to us to be a great window of opportunity to gain exposure to what we, along with Goldman Sachs, Blackstone, and many others, think should be a core component of every portfolio.
Real Asset Investments in a
The Fund has holdings which are denominated in currencies other than sterling and may be affected by movements in exchange rates. The Fund may invest in derivatives to reduce risk or cost and/or generate extra income or growth. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. Part of the fund may invest in bonds. Investment in bonds and other debt instruments will be impacted by factors such as changes in interest rates and risk of default by the issuer.