Macquarie 2019 Real Assets & Alternatives – Themes & Outlook

Investing
  • Investments in physical assets like real estate, infrastructure, commodities, and natural resources may provide absolute and risk-adjusted returns that exceed those of many equity and fixed income investments
  • Many real asset classes also generally share inflation protection as a common trait

Even with inflation, infrastructure asset demand can persist

  • Concerns about economic conditions and other factors could trigger a shift in sentiment that may broadly favor listed infrastructure in 2019
  • Potential for higher inflation arising from central bank monetary policies to help stimulate economic growth over the past few years is a longer-term risk for all asset owners; many infrastructure assets can charge prices that are wholly or partly linked to inflation
  • This defined and automatic ability to pass through inflation to customers is in contrast to the situation faced by companies in competitive markets, which may find that as their costs rise with inflation, competitive pressures prevent them from raising prices and hence their profit margins and earnings may be squeezed

Trends in natural resources could shape the investing landscape

  • Beyond the longer-term tug of war between traditional fossil fuels and renewables lie both shorter- and medium-term supply dynamics that we believe should support the sector across the value chain for several years
  • Activity in the US will continue to be focused toward energy infrastructure
  • In Australia, rebalancing of the energy landscape and refinancing bank loans into longer-dated institutional debt will continue to shape the market as borrowers and governments look to remove refinancing risk
  • Global opportunity for renewable energy continues to be a major theme in the market as it becomes an increasingly competitive and attractive source of generation with falling technology costs and efficiency improvements; expect to see innovative financings and consolidation of portfolio ownership in established technologies including wind and solar, knowledge sharing leading to new transactions across regions such as offshore wind into the US, and increasing comfort with newer technologies like battery storage
  • In crude oil, we see significant issues from major producers such as Venezuela and Iran; trends are positive on demand – some from expected sources such as China and others from underappreciated areas such as India; these trends could support higher oil prices into 2020; also bullish on certain North American shale plays
  • Base metal that is appealing as we enter 2019 is copper, which struggled in the latter part of 2018 due to increased trade tension between China and the US; China accounts for 50% of worldwide demand for copper and the Chinese economy appears strong for the near to middle term, firming up foundational demand for the metal

Listed real estate markets show resilience, maturity

  • REITs came under pressure in recent quarters, as rising US interest rates led to underperformance relative to other equity assets during a stretch of 2018
  • Continued US economic strength generally led to stabilized yields and positive earnings surprises in sectors such as retail, which more recently appeared to buoy REIT markets
  • Strong-performing sectors such as residential REITs in Germany and Sweden, and manufactured homes in the US, are examples of areas recently driving growth within REIT markets; Asia, where housing continues to be expensive, is a region where we see notable weakness, and our strategy is well underexposed there
  • It has been our experience across various market cycles that real estate securities often can perform soundly in a steadily rising rate environment when there’s also economic growth; so a key barometer of the year ahead is clearly the economy
  • We continue to monitor late-cycle economic phenomena such as US wage growth that could signal higher inflation or the potential for widening credit spreads, and sharper interest rate spikes that could have negative effects on REITs in general
  • Our strategy is underweight in Asia; we see Hong Kong as the world’s most expensive real estate market by many measures, but especially due to its housing market; Sydney housing has taken a turn to the downside; we have zero exposure in China which has an obvious debt problem; Europe still has the benefit of low interest rates and while European REITs have trailed US REITs, we continue to find parts of its residential markets attractive
  • The US by contrast has the highest economic growth currently, and we are monitoring our US investment mix, remaining opportunistic and discriminating; sectors like self-storage in the US are negatively affected by oversupply, while US retail continues to grapple with headwinds from the ongoing shift to ecommerce
  • Nascent trends such as cashier-less stores are clearly worth monitoring and speak to the validity of the “bricks and clicks” models that blend online and physical business presence
  • Private capital flows have often helped keep cap rates stable, even in the face of rising interest rates; a strong flow of private real estate investments in a market could inhibit publicly traded REIT performance at times; it also could alter the overall dynamics of a market in other ways that may benefit the larger real estate market to the upside
  • We believe fewer broad trends can be easily exploited currently in the REIT markets; secular growth stories exist but we think it’s also important for investors to recognize the late cycle

Electric vehicles have broad implications for infrastructure

  • At present only around 0.26% of light duty vehicles globally are electric; globally, EV sales have increased at a CAGR of 61.5% over the last five years, with China, Europe, and the US accounting for the bulk of new sales; by 2030, sales of EVs are expected to be 29.9 million per year
  • There are several positive, self-reinforcing trends acting on EV sales; falling battery costs lower the cost of EVs; increased demand for EVs increases the demand for batteries and therefore provides an incentive for further battery cost improvements
  • EVs require a charging network, something that has clear infrastructure traits such as network effects, barriers to entry, and high capex requirements
  • Greater use of EVs is likely to see electricity demand grow more rapidly than it has in the past and the pattern of electricity consumption over the course of any given 24-hour period is likely to become more uniform as people charge their cars during cheaper, low load periods; this may have important implications for electric distribution system operators in terms of the demand placed on their networks and their capex requirements
  • The speed of batteries’ response to outages makes them ideal for fast-frequency response services; average vehicle miles traveled on roads are also likely to rise due to the low marginal cost of a car mile in an EV; toll roads could be another potential beneficiary of this trend

Macquarie Asset Management: 2019 Global Investment Outlook – The Way Forward

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