the real assets ‘pick ‘n’ mix’
7 July 2017
Everyone loves a ‘pick ‘n’ mix’ because of the variety. Some find comfort in an old‑fashioned humbug. Others prefer the fizzy tang of a flying saucer. Personally, I don’t get aniseed balls! You can also mix and match to suit your own tastes – why bother with a bag of lemon sherbets when you can create your own mix of wine gums, gobstoppers and fizzy cola bottles.
This ‘pick ’n’ mix’ approach is also handy if you’re thinking about investing in real assets.
Real assets – like property and infrastructure - have a number of tasty features, and now is a great time for schemes to up their allocations.
- Yields for many traditional assets are low – 20-year gilts yield well below 2% pa. The additional income yield offered by many real assets is attractive if your scheme can stomach the illiquidity and higher entry costs, and make a long-term commitment. For example, by investing in commercial property with a 20-year lease, you can harvest an additional income yield of almost 3% pa above gilts.
- This income often has an implicit – and sometimes explicit – contractual link to inflation. Great news for schemes that expect benefit payments to rise with inflation.
- And finally real assets offer something truly different to liquid growth asset alternatives (like diversified growth funds) which don’t tend to hold these less liquid investments – so an allocation can help to better diversify investment portfolios.
So if you’re tempted, how do you go about making an allocation? Real assets have several features in common, often blending elements of income and growth. However each one has its own distinctive flavour - so just like a good ‘pick ’n’ mix’, you can choose the asset that best meets your scheme’s specific strategic needs.
If you are de-risking, but do not want to lock into ultra-low gilt yields, long‑lease commercial property is a worthwhile alternative. Income from these properties is expected to increase year-on-year with inflation, and is secured against the value of the premises. If cash-flow matching is important to your strategy, ground rents or income strips may be a good option, with 90% of the long-term return expected from income.
If growth potential is more important to you, perhaps infrastructure (ie businesses with near monopolies and considerable pricing power) or residential property (ie high quality, purpose-built accommodation attractive to young private renters) is a better fit. You may already hold mainstream commercial property, so rather than more of the same, adding infrastructure or residential property can be a great way to diversify and spread the liquidity risks.
With a wide variety of options to choose from, our pick ‘n’ mix infographic can help you consider which real assets may suit your scheme best.
I think that mixing and matching is a way forward for many schemes (see this case study), and managers are responding to this demand. For example we are seeing more multi-asset, secured income funds that invest in a blend of illiquid real and other private assets, focusing on returns driven by contractual cash flows. So while a pick ‘n’ mix is a nice blast from the past, I see it becoming a taste of the future.
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