Han Dieperink: The moment for real assets
Han Dieperink: The moment for real assets
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
Real assets are physical assets, especially things that we see around us every day and on which every economy runs. The two most important categories within real assets are real estate and infrastructure.
Due to their physical nature, these assets are tangible and cash flows from these assets (rent, tolls, port fees) usually continue even in uncertain times, which ensures stability. Due to this stability, debt capital is often used, which enables returns that are equal to or higher than the return on shares.
Largest asset class in the world
When looking at the value of all real estate and all infrastructure, real assets are probably the largest asset class. There is a direct link with inflation, because automatic inflation compensation is often part of cash flows from real assets. The result is that real assets can offer a lot of added value to an investment portfolio, especially for long-term equity investors who aim for a relatively high return, but at the same time want to reduce portfolio risk. An important part of that return consists of regular cash flows, which help reduce risk. As a result, the correlation with other investment categories is small, which means that value development is not very dependent on developments on the stock exchange. This also improves the stability of the portfolio, without sacrificing returns.
Spreading protects against fear of heights
Many stock investors regularly get afraid of heights, especially if the stock market has risen in a short time. A natural reaction is to leave the market for a while. That usually doesn't end well. After all, the stock market has overcome every historical correction and there is plenty of research showing that timing the market is a fairly pointless exercise. Although everyone rationally recognizes that it is better to stay put, emotions play a major role in uncertain times. Instead of liquidating a share portfolio, it is better to diversify, where on the one hand real assets provide a return comparable to shares in the long term, but on the other hand provide a clear diversification and, as a result, reduce the risk .
Longer cycles
An important reason that real assets provide diversification is that they generally have much longer cycles. While the typical economic cycle is about 5.5 years, the average real estate cycle is about 18 years. For infrastructure it can be even much longer. We are now at the end of that cycle in various real estate markets. This is due to the increased interest rates, but also to structural developments such as working from home, which have particularly affected office buildings. But every end of such a cycle is immediately the beginning of a new cycle. This is because central banks will soon lower interest rates, but sustainability (energy transition) also plays a major role. Moreover, there is usually not too much construction in this cycle. Rather too little. For example, there is a major housing shortage worldwide.
Additional opportunities for infrastructure
In many developed countries, much infrastructure is subject to overdue maintenance. This infrastructure often dates from shortly after the Second World War and the typical lifespan of 50 years has often been extended by several decades. Since governments are confronted with significantly increased debts, they are keen to attract private investors. Moreover, in many countries the electricity network is completely insufficient to cope with the energy transition, also because data centers - including infrastructure - are becoming increasingly larger and require more and more energy.
Alternative to owning real estate yourself
For many investors, real estate is already a relatively large investment category. The Dutch government has done everything it can to make this category as unattractive as possible for private investors. Often the only solution is to sell the objects. At the same time, real assets do offer cash flows that are comparable to rental income from real estate. It also offers a solution for the many specific risks that property owners run. Furthermore, real assets are capital intensive. That is why borrowed capital is often used. It is then important that the use of foreign capital is handled prudently. Here too, much specific risk is prevented by spreading.
Sustainable impact and artificial intelligence
Much of the capital that is now invested in real assets is used to make existing buildings more sustainable or in infrastructure that makes the energy transition possible. Consider not only electricity networks, but also the equipment that makes fossil-free energy possible (particularly solar cells and wind turbines). Furthermore, real estate and infrastructure benefit from the strong growth of artificial intelligence, which requires many data centers. This data also provides increasingly better insight into the risks associated with real assets and with that insight there is better risk management.
Substantial part of the portfolio
Real assets are certainly not a small satellite in a broadly diversified portfolio. They belong to the core of the portfolio and their inclusion only makes sense if they are a substantial part of it. They are part of investments in private markets and, due to their often limited liquidity, they have a term that is much better suited to the investment horizon of the average investor. This is actually a disadvantage of shares and bonds. No one will advise investing in it for a period of days, weeks or even months. In that respect, daily liquidity is an unnecessary luxury. In addition, real assets also add a lot to portfolios, both in terms of risk and return.