Real assets: the inflation play
After years in which the inflationary dragon lay slumbering, it has woken with a vengeance. Inflation has become impossible for investors to ignore and with oil and food prices both high and rising, it looks likely to remain a threat for some time to come.
For investors this presents a challenge, as inflation erodes the value of assets and cash flows. What can they do to protect themselves from rising prices? In attempting to inflation-proof investment portfolios, investors might consider an allocation to so-called ‘real assets’, the value of which is directly linked to rising prices.
Real assets have intrinsic value. Examples include gold, copper mines, oil fields, real estate and land. Assets that fall into this group tend not to have their value corroded by inflation. Basic resource stocks have outperformed the broad index in each of the last five years of rising inflation in Europe, whilst oil and gas stocks outperformed in four out of the five periods. Meanwhile, real estate and infrastructure both offer bond-type cash flow streams which can be extremely attractive in times of inflation, when the value of coupons from bonds themselves is being eroded.
In addition, the gearing inherent in most property investments acts in favour of these assets during bouts of inflation – the real value of the debt decreases as the capital value of the asset increases. For the astute investor, this represents a valuable opportunity set.
The FF Global Real Asset Securities Fund invests in securities backed by real assets within the energy, materials, industrials, real estate and utility sectors. The fund is relatively concentrated, with around 50-70 stocks. I may choose any company in the relevant sectors, regardless of size or location.
An important step in my analysis involves meeting companies across different value chains to build a better picture of the forces impacting their profitability. Our global pool of research analysts enables me to search for the areas of greatest pricing power and competitive advantage. This often leads me to some of the best investment opportunities at each point in the economic cycle.
One such current holding in the fund is Newcrest Mining. This is a low-cost gold producer with multi-national operations and development projects in low risk geographies. It has high quality assets and a strong project pipeline that can drive long-term, sustainable growth. This is one of a number of exciting opportunities the fund seeks to take advantage of.
It is worth emphasising that real assets function as more than an inflation-hedge within a portfolio. In developing an allocation to commodities, basic materials, industrials, energy, real estate and infrastructure, investors are also inherently tapping into the growth potential of the long-term secular development of emerging markets. The demand, and supply, of many of these assets is undoubtedly part of the longterm emerging markets investment case. Whatever recent stalls have occurred in the emerging market economies, the long-term development story remains compelling.
Take China and India, for instance, home to 38% of the world’s population. They represent the largest consuming population in the world. Within the next five years, about half the population will fall within the ages of 15 and 49 - the most productive and highconsuming age bracket. This is set against a backdrop of huge government stimulus packages that are being applied in the emerging markets, China in particular.
It seems probable that the next capital spending cycle is likely to be dominated by public money. By buying into companies which engage in mining activities, build infrastructure, provide engineering services and manufacture basic materials, investors afford themselves a slice of the action without encountering the cost and complexity of direct ownership of commodities.
Whether you are looking to construct an exposure to secular trends, or inflation-proof a portfolio, an allocation to real assets might well provide a welcome solution.
Notes to editors
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