Inflation-resistant investing: diversification in real asset markets

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I’m Darius McDermott from FundCalibre, and I’m delighted to have Vince Childers with us today. He’s the lead manager on the Cohen & Steers Diversified Real Assets fund. Vince, good afternoon and welcome.

[00:14] Hey, thank you for having me, Darius. Happy to be here.

So, this is a fund which has a mixture of assets within it. So maybe you could give us a brief introduction to the fund and what type of assets that actually you do include in your real assets fund.

[00:28] Yeah, sure. So I think the main thing to understand is that we’re a real assets manager focus really on the liquid listed, exchange-traded markets for real assets. As you point out, we take a pretty diversified approach. The way I tend to explain it to people is there are a lot of sectors, industries and securities that we think make sense as, as real assets in that liquid space but overall, they can be kind of boiled down into 4 core categories of real assets: global real estate securities, so REIT structures where you have them, but owners, operators, developers of commercial real estate globally; exposure to commodity futures in the portfolio, so sort of the here and now of supply and demand commodities; ownership of global national resource equities, so agribusiness, energy mining and the like. And then finally the global listed infrastructure universe, which really spans a number of industries and sectors. Everything from kind of communications, midstream energy, utilities its as et cetera. And about 90% of our portfolio is really concentrated in those core four real assets.

So, that is a nice mixture of diversification within those different types of assets but let’s pick on real estate to start with. Real estate can cover a wide range of different asset and sub-asset classes itself from sort of data centres supporting cloud and the growth of AI to care homes or warehouses. What sort of exposure can this fund have and maybe what areas you are favouring at the moment?

[02:14] Yeah, so I think the short answer is pretty much everything you mentioned is in there in one way or another. So really what we do, and this is true of each of those core four categories I mentioned, but in the context of of real estate our approach is really going to start with something like the FTSE EPRA Nareit developed benchmark for real estate. And that gives us a very kind of widely diversified industry structure that, you know, really does span everything from residential, industrial, retail, healthcare, office and so forth.

At the moment I guess if I had to say, you know, we’re probably most underweight in the portfolio office properties, and within that it’s mostly coastal office. You know, I think the reasons why from a fundamental basis I probably don’t need to go into, at some point of course, you know, we think valuations will be likely to kind of catch up with fundamentals and in that space even though it’s a small part of the benchmark and even smaller part of our portfolio, is something that, you know, is undergoing a bit of a transition [that] we think still merits an underweight. We’re more positive at the moment on for example data centres, self storage, some things that are typically seen as a little bit more defensive and, you know, likely could see a little bit of a bounce if we do start to see central banks lighten up on interest rates.

Yeah, I mean the data storage is obviously a huge growth area as the demand for whether it’s e-commerce or AI, you know, all sorts of different parts and you can see that being a real growth area so I’m not surprised that that’s something that you are overweight on at the moment. Maybe we should then touch on infrastructure. It’s another big part of the fund. Again, infrastructure is another one of these broad terms with lots of sub-sectors. Maybe you could tell us about the sort of infrastructure assets that you like generally, and again, where the fund may be tilted today.

[04:32] Yeah, so infrastructure right now versus our benchmark is actually our biggest overweight at the moment you know. I would say in general we like infrastructure broadly just because valuations kind of look uniquely attractive at the moment. Particularly when we start looking at looking valuations versus say global equity indices. So just to make that a little bit more concrete: Biometrics infrastructure is trading at something like a 7% discount. Just take something like a simple EV to EBITDA figure, something like that. Normally though, the important point is, normally and historically infrastructure’s actually created a premium more in the sort of 10-11% range. And so we moved to this kind of discounted valuation situation and, you know, really for, you know, most of the post GFC [Great Financial Crisis] decade, this is probably the second most attractive valuation period we’ve seen really just following Covid and sort of Spring of 2020. And so I think that the valuation story is there.

I also think that one of our bigger macro views is that we’re probably going to be looking at something like a decelerating growth environment as we look ahead a year or two, and historically infrastructure’s played a bit more defensive role and offered a bit more downside protection leading to relative outperformance when, you know, growth has kind of slowed. And then, similar to the comments I made about real estate, infrastructure very often will tend to perform well towards the end of rate hiking cycles. And so we can see that as a potential tailwind or a catalyst for unlocking the valuation we see within infrastructure.

I’d say we’re overweight, probably most overweight midstream energy, so your pipelines, energy transport, and towers are another overweight for us. And I think the midstream story is really a story about North American discipline in the in the energy sector, meaning, you know reducing CapEx de-leveraging, focusing on balance sheet repair and free cash flow generation. This is a broad story and sort of the North American energy situation that applies to midstream as well and ends up making these assets look pretty attractive.

And then something like towers, I think is a more straightforward valuation story as well with the likelihood of of getting that interest rate kicker if we turn out to be right and eventually you know, we start to see rate cuts on the horizon.

And then maybe then to the last set of potential assets for this fund which are commodities and natural resource equities. Could you tell us a little bit about which areas that you can invest in there? Because you did mention futures for commodities and natural resource equities, and again, which areas are are attractive on your metrics today?

[07:42] Yeah, so the first thing I would, I would want to do is just be clear that we draw a distinction between commodity futures exposure you know, so getting kind of the economics of actual commodity futures contracts, and this would be akin to something like the Bloomberg Commodity Index for those who are familiar with diversified commodity indices. But we would draw distinction between those types of economics and exposures and then the resource equities. So the resource equities are going to be your producers of many of those commodities. And these are assets that are going to be valued and priced with the long term in mind, you could sort of think about it in one way. The commodity futures exposure, as I said earlier, sort of gives us the economics of the immediate term supply and demand, whereas the resource equities will sort of discount a whole future of expected supply and demand scenarios. And so they both do something a little bit unique in the portfolio.

Now, the main takeaway in the context of a real assets portfolio, where most investors are going to come to us looking for inflation sensitivity, basically, you know, asking question: if we get some kind of acceleration in inflation rates or inflation surprises to the upside versus expectations, do you expect to outperform, say core stock and bond type exposures? And more often than not, it’s the exposure to both commodity futures and the natural resource equities that give you the biggest part of the inflation sensitivity in a portfolio like this. So in terms of the diversification benefits, I think there’s that inflation sensitivity there.

And then with commodity futures in general, just because they’re not equities, unlike everything else we’ve talked about, they typically have a lower correlation, a lower beta to equity indices, and just on average are much more diversifying to the core exposures in for most investors.

So, maybe then that leads me nicely into my last question, which is for a retail buyer of mutual funds or open-ended funds or closed-ended funds for that matter, how does this lovely mixture of assets fit into an end individual’s portfolio? What characteristics does it bring as part of an individual’s wider portfolio?

[10:05] So the way I tend to think about this is that if I look through most investors’ portfolios and I look at their asset allocations, what usually stands out is that there are two primary exposures in there, right?

They’re exposed to an equity risk premium, basically to, you know, stock – how are the global stock markets going to do? And then they’re going to be exposed to some kind of fixed income duration type risk premium, basically what are bonds going to do, right?

What we see historically is that when you get kind of unexpected inflation, inflation surprises and so forth, you tend to get below average returns out of both stocks and bonds at the same time. They stop diversifying each other as well. I think even, you know, if any of us can kind of remember at this point, 2021, 2022, and much of that period we had this kind of stagflationary shock where we saw unexpected inflationary outcomes and sure enough correlation of stock bond returns jumped then and it was correlation to the downside and investors are kind of inherently exposed to that, most investors. And so part of what we’re trying to do is offer exposure to assets that actually tend to outperform when faced with that type of of environment.

And the idea very simply is that if we can intelligently construct this real assets portfolio, the investor can kind of slot it in as a sort of utility player having a supporting role in a broader asset allocation to kind of modulate that inflation sensitivity of the overall asset allocation from say, something negative to maybe something more neutral or at least in the direction of neutral so you’re less sensitive at the overall level of the portfolio to inflation shocks and inflation surprises.

And you know, what the long-term data tells us is that you can do this with these types of assets, but also they’re diversifying enough just on average over time, that they can actually make the whole portfolio more risk / return efficient as well. And so there are a number of kind of benefits that can be harvested by thinking about a diversified real asset portfolio, again, playing that kind of utility role or supporting role in the asset allocation.

Vince, thank you very much. If you’d like more information on the Cohen & Steers Diversified Real Assets fund, please do visit FundCalibre.com.