MASTERCLASS: Real Assets - April 2017

Long considered a valuable portfolio diversifier, real assets have recently attracted growing interest due to global growth trends and U.S. policy. A diverse panel of real assets experts joined Asset TV to evaluate the future of real assets given the current climate as well as share their outlooks - from infrastructure, real estate, and precious metals perspectives.

  • Larry Antonatos - Managing Director, Portfolio Manager at Brookfield Asset Management's Public Securities Group
  • Edward O'Donnell - Head of Liquid Real Assets for Americas, Global Client Group at Deutsche Asset Management
  • Maxwell Gold - Director, Investment Strategy at ETF Securities

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  • 56 mins 05 secs
Gillian: Welcome to Asset TV. I’m Gillian Kemmerer. Real Assets have long been considered a valuable diversifier in investment portfolios, but recent macro trends have brought the asset class to the forefront, from Donald Trump’s infrastructure ambitions to a new dawn in global growth, Real Assets across a wide range of sectors are poised for success. Today we have brought together a panel of real estate infrastructure and precious metal experts who will share their outlook for 2017. Welcome to the Real Assets Masterclass. Thank you all so much for joining us here today. We’re thrilled to have you and I think it’s a very timely discussion right now, especially in light of some of the fiscal expansionary policies of President Trump. So, Larry, I’m actually going to start with you, given the diversity on the panel, it’d be great if you can just give us a quick intro into some of the areas that you’re focused on.

Larry Antonatos: At Brookfield we’re focused principally on infrastructure and real estate. We invest in both private fund structures as well as listed securities. Specifically I am working on the listed securities team. We have significant investments in both equity of real estate and infrastructure companies, but also debt positions and I think that’s something that most people don’t think about immediately when they think about real assets, they’re thinking about equity ownership of buildings or infrastructure assets, or stocks of companies that own those assets. We think that debt investing is also an important part of a diversified real asset portfolio.

Gillian: Excellent. And I believe you have something in common with Edward who’s sitting next to you. Tell us a bit about what you do at Deutsche.

Edward O’Donnell: Very similar, in Deutsche Asset Management we have a 41 year old legacy of investing in real estate and infrastructure on behalf of our clients, and it spans the spectrum from public to private equity and debt. So there are solutions for a variety of different clients in there.

Gillian: Okay, perfect. And, Maxwell, you’re on a slightly different track, tell us more.

Maxwell Gold: Yeah. So we at ETF Securities are a global commodity ETF provider as well as providing solutions to other asset classes. That’s really our footprint globally. And here in the US, we’re providing multiple solutions in the physically backed precious metals space, but as well as we’re expanding our footprint globally in the commodity asset class. And certainly that’s sort of my realm of expertise is in the commodities asset class, sort of our outlook from a macro top down perspective as well as sort of how we incorporate these unique positions into diversified portfolios. And really, you know, try to bring attention to them because they are a bit of an overlooked asset class, particularly in this market environment, we do see a lot of benefits.

Gillian: Okay. So we have a nice diversity of perspectives here. I think we’ll really drill down into infrastructure and commodities maybe largely precious and base metals. So let’s start with looking at the current macro landscape. The Federal Reserve is approaching its dual mandate, we are finally in a rising interest rate, all be it slow, and rising inflation environment. Larry, starting with you, how are you looking at the rising interest rates and inflation, particularly when evaluating your own portfolio?

Larry Antonatos: So one of the things that I think about is the significant move in interest rates that we had in the fourth quarter of last year, particularly after the election, in investing in any asset class you’re always focused on what interest rates will be doing. My belief is that the significant move we had in the fourth quarter really sets us up for a nice environment moving forward; specifically the big move is behind us. And as we move ahead forward any increases in interest rates, I think will be much more measured than what we had in the fourth quarter of 2016.

Gillian: How long do you consider us to be persisting in a low interest rate environment, is there a specific basis point that you’re looking for to say, “Okay, we’re out of this?”

Larry Antonatos: I think we have actually just sort of shifted around the corner from an environment where interest rates are low and falling. Now we’re in an environment where interest rates will be low and rising, rising slowly, but still remain low. I don’t see significant drivers that would move interest rates meaningfully higher in the next 12-24 months.

Gillian: Okay, Maxwell, from the precious metals perspective.

Maxwell Gold: Certainly. So when you think about interest rates, a lot of attention is focused on the headline number, like the 10 year treasury interest rate out there at about 2.4% now. And as we just mentioned, there was a big rise in rates following the election. But what we’ve also seen commensurate at the beginning of last year was a rise of inflationary pressures. And particularly for gold and silver, which are traditionally viewed as more monetary assets, we see that real interest rates are key drivers for those two. And what we’ve seen is that real interest rates we do expect to remain consistently low and range bound this year. Right now on a 10 year basis we’re at about 40 basis points, and historically precious metals in particular have performed well in a rising rate environment. But more importantly on a rising real rate environment, they still have fared very well. So overall we do expect rising inflation moving in conjunction with what is likely going to be, you know, slow and rising, but nominal rates should be a good environment for gold and silver particularly to perform well.

Gillian: And the real interest rate, that’s an important distinction. Edward, to you, same question, how are you looking at the rising interest rate environment?

Edward O’Donnell: It’s an important question; real estate and infrastructure are capital intensive assets. They do throw off great cash flows but they’re not self-funded. So if you want to maintain them, let alone, grow them, you have to borrow. Now you have some debt on the balance sheet, some leverage, some interest rate sensitivity. But to Max’s point, where are we along that curve? The sensitivity is further to the 30 year where there’s good support and stability right now, for a long dated real asset. Also there’s a lot of pass through, in something like infrastructure, which could be looked at as a portfolio of monopolies, we calculated 81% inflation pass through. So why are rates rising? If they’re rising because inflation is rising we can pass through that rising rate and rising inflation much more quickly than broader equities could for example. So it’s actually a positive environment or us on a relative basis.

Gillian: Okay. The cover of The Economist last week was a picture of a series of balloons rising. They had various flags of countries from South Korea, to Brazil, to Russia on them. We’re entering this new dawn of synchronized global growth. And I’d be interested to hear, Larry, starting with you, your outlook for (a) how stable that growth is and if we can really count on it in 2017 and (b) how it impacts your portfolio.

Larry Antonatos: So I do think that global growth will be positive and increasing. But I don’t think it’s going to significantly surprise to the upside. There still are a lot of headwinds in many global economies. That actually is a relatively nice environment for real assets; you want growth but not too much growth. Frankly, if you have too much growth there are other asset classes, more cyclical asset classes that could grow faster and outperform real assets. So I do think that the environment that we expect in the next 24 months is in some ways a Goldilocks environment for real assets. And that should be a good backdrop for real assets.

Gillian: So optimism, but tempered optimism is the way to go here.

Larry Antonatos: Yes.

Gillian: Edward, what about you, how do you think about het changing global picture here?

Edward O’Donnell: It’s positive, we often look at the first derivative, not if something is positive or negative, but accelerating or decelerating. So if global growth goes from 2 to 3 that’s positive for us. If it goes from 10 to 7, 7 looks great, but it’s cooling down. So when we look at acceleration for growth, some acceleration on inflation, but interest rates remain benign, that’s a pretty positive environment for real return, from our perspective.

Gillian: Developed versus emerging, are you particularly bullish on one or the other?

Edward O’Donnell: Well, I challenge the term a bit, you know, for example, if you look at infrastructure spending by governments in the developed world, it’s 3.5% of GDP. We haven’t been that low since 1948. So I would recast, that is emerging versus submerging, in terms of spending on something like infrastructure.

Gillian: I like that, well put. Maxwell, what about you, how do you look at the changing global growth picture in regards to commodities?

Maxwell Gold: So I think overall I’m in agreement that globally we see a trajectory of increasing GDP per capita. But where I think the catalyst is still going to remain is really in those emerging markets. We’ll likely see continuing muddled through growth in the US at about 2½/3% for the next couple of years. Europe, I think has bottomed out, but a lot of focus right now has been in China. What we’ve seen is that China is beginning to stabilize its growth. And what we do expect is that that should be a boon for overall commodity demand, as we’re seeing sort of the second half of the overall global economic cycle, begin to pick up in terms of expansionary manufacturing, increase on industrial production, as well as rising inflation. And it’s really on that second half of the expansion during a cycle where you do see growth moving in line with rising inflation as opposed to growth with disinflation, falling recession. And then that environment historically, real assets, in particular commodities have performed well. And it’s really where we see opportunities for the precious metals space and more of those, you know, other metals such as silver, platinum, palladium, which have a higher cyclicality sensitivity to them, which are more sensitive to the industrial production cycle. And so overall, we do expect the global picture to remain robust. But we think that, you know, there’s opportunities, you know, maybe outside certain developed markets, which are much more in the focus right now in terms of asset class investing.

Gillian: You referenced China, but we always think of India perhaps as the sleeper, it has a very measurable change in demand from gold, but can you think of any other areas where India might come out and become at the forefront for some of the metals that you’re looking at?

Maxwell Gold: So, certainly a lot of focus has been on infrastructure spending, especially with US politics and attention on policies there. But if you look globally, the majority of infrastructure spending is mostly going to come from China and India. And where we do see a lot of catch up in terms of them trying to, you know, meet with the overall trends that are within their developed market peers. And so we see most likely an increased demand for industrial metals as well as for energy. India is a net importer of its energy. And what we’ll likely see is, you know, expansion in those sectors of traditional fossil fuels, but as well as development into more renewable energies of the overall commodity picture.

Gillian: Okay, so certainly one to watch. Now, before we go into specifically Donald Trump’s infrastructure regulation and legislation, which I know that we’re going to talk about sort of at length here, we’ve seen a change in both the pace of adoption as well as the success of some of his policies that he’s put forward already. Within his first 100 days we’ve seen the speed of let’s say the immigration ban, but also we saw the Healthcare Bill shot down. Larry, are there any particular policies that you’re really keeping an eye on in 2017 that are causing perhaps some uncertainty in the regulatory outlook?

Larry Antonatos: Well, some things that impact us significantly in the infrastructure market are energy policy, because a significant amount of the public infrastructure universe is US oil and gas pipelines. And Trump’s policies there are very positive. So that’s good news for us. The other aspect of his policy that’s getting a lot of attention is infrastructure spending, I think that’s very good news for drawing attention to the infrastructure asset class, particularly as an investable asset class. So it’s drawing more attention from retail investors, institutional investors, financial advisors etc. But I do think that the scale of that infrastructure spending, while it will be large, it’s not going to really move the needle in terms of US economic growth. Hopefully what we get is infrastructure spending that is truly additive to the long term growth rate of the country, because it allows goods to be moved more cheaply, more efficiently, etc. And that’s a long term upward driver of economic growth. The one key thing that all of us in every asset class we’re looking at is tax reform, because tax reform will really get every company going more profitably and that is really the key thing that we are focused on now.

Gillian: Focused on corporate versus personal though?

Larry Antonatos: Corporate Tax Reform, yes.

Gillian: Okay. Edward, how are you thinking about some of the regulations that Donald Trump may roll out or deregulations I should say, through the latter part of 2017?

Edward O’Donnell: Well, first of all there is a long time horizon between what you say on Twitter and what concerns a project. So it’s in the tweet, but is it in the balance sheet, remains to be seen. Some sector specific comments, energy, certainly very positive under Trump. Keystone XL pipeline, being improved in March, that’s positive immediately for a company like TransCanada. In general, midstream energy benefits, you don’t see the bottleneck you may have expected under Clinton, faster realization of midstream cash flows, that’s all positive. A little question mark about MLPs, and the favorable tax treatment there, right. Communications, mixed bag, cell phone towers, terrific book of business. The first tenant operating profit margin 35%, subsequent tenants in the 70s, average number of tenants per tower 3.1, but under Trump’s administration, if you collapse the number of major carriers in the US from 4 to 3, that average number of tenants comes down, that’s a threat if you own cell phone towers like American Tower or SBC. On the other side, the Head of the FCC wants to take a weed whacker to the rule book, net neutrality’s back on the table, that’s positive for cell phone towers because it’s tiered pricing for their underlying tenants like AT&T, Verizon etc, mixed bag there.

Transport, every pro coal comment is positive for rail, rail is a non-benchmark play, but we like it. Coal is one of the cheapest most profitable things that they ship, that’s positive, toll roads could benefit. But how do you invest in it, Transocean, Ferrovial, those are … Transurban, rather, and Ferrovial would be beneficiaries of toll roads in the US. Utilities, water would be a clear winner under Trump, it’s just re-spending, you know, 75% of our water mains in the US are 25 years old, 25% are 75 years old. Not far from where we’re sitting the water mains are made of wood.

Gillian: Terrifying thinking.

Edward O’Donnell: Yeah, because it will create new assets. And there’s a lot of free marketing for the space, there is a lot of capital potentially. But people talk about Public Private Partnerships taking off in Europe. In the US there’s a ceiling to that called Muni Bond Market. So there’s all of this tweeting, create necessarily new assets, we combine the portfolio remains to be seen, certainly some free marketing.

Gillian: Great points all around, Maxwell, for you the same question.

Maxwell Gold: So I think there’s a lot of attention on that side, but to take maybe a different perspective of the impact of some of these policies, particularly where we’ve seen sort of year to date beginning with the inauguration in January. We’ve seen a lot of policy uncertainty, and certainly we see gold in particular respond, have a positive correlation to that uncertainty. And so we’ve seen sort of that demand for, just not only market uncertainty, but sort of where we go here from a monetary standpoint, but as well as a fiscal standpoint. What is the real impact? There’s not a lot of clarity or transparency around the details of some of the proposed policies. Think from a big picture standpoint, markets have sort of run up post election particularly in equity markets. And from our perspective I think we’re seeing a demand for more of a way to hedge against some downside risk. We’re seeing record lows in terms of the VIX, in terms of equity volatility. And certainly we haven’t seen a correction in the equity market, so, not to say that this will derail the trajectory of the overall recovery or overall expansion under our Trump administration. But I think certainly we’re seeing demand for more of a way to hedge against some potential short term volatility or downside. And additionally, I think the biggest impact from some of the major policies, whether it be tax reform deregulation, but certainly trade.

Trade has caught a lot of attention, particularly in terms of [inaudible], but sort of trade negotiations with China, one of our biggest trade partners. And overall I think that will have an impact, whether it will be positive or negative on the dollar. And if you’re talking about gold, silver, platinum, palladium or other commodities, certainly the direction of the dollar is going to have a large impact of the overall asset class and the expectations throughout the year.

Gillian: Yeah, and that flight to safety was a big story at the end of last year and may continue to be this year, depending on the level of uncertainty.

Maxwell Gold: Right. And I think you certainly, going back to that risk aspect, I think currently markets, particularly equity markets are under-pricing that risk of potential delays or compromise. It’s not to say that we won’t get some kind of bill on infrastructure or some kind of tax reform through. But I think markets may get a little bit impatient and look to maybe, you’ll begin to unwind some of the positions they have in equity markets, based on valuations and where we’re seeing corporate earnings meet those valuations.

Gillian: Very interesting. I’m going to come back to you, Larry and Edward about infrastructure policies specifically. We’ve seen mounting public deficits pressuring governments globally to privatize infrastructure. Donald Trump has said he’s looking into a deficit neutral policy for infrastructure, with tax credits. Give us a sense of what you see coming down the pipeline in terms of the nature of the infrastructure spending, and whether or not you think it will be tipped public to a private. You already referenced the muni bond market, Edward, why don’t we start there.

Edward O’Donnell: It provides a natural ceiling to it. We do think there’s tremendous interest in this. And I think the reason is when other candidate was saying infrastructure, they were really saying jobs that can’t be outsourced, it’s popular to do that. The case is clear, we have under-addressed infrastructure as a liability since Eisenhower. And after you have stimulus packages, now you’ve pressured your balance sheet. You selloff a jewel in the crown asset that our parents couldn’t buy, now it’s a publicly held security, you can buy 12 airports around the world, toll roads, sea ports, cell phone towers, that’s all very attractive. In the current administration they do talk about infrastructure spending, the Wilbur Ross plan, there’s a trillion. But will the conservatives and the GOP, who have some strength, allow that to be spent with debt? No. Hence Public Private Partnerships as a way to solve for it, or asking states to do more with utilities, for example, is a way to create a solution and create that. So it may not create new assets, but I think there has to be a compromise between Public Private Partnerships and what’s going on now. Look at Pemex in Mexico, okay, clowns around the circus, ticket prices go down. To their credit they raised their hands, had a regime change, a reform change, let the analyst spirits, roaring fund capital come in. You want private enterprise to run this asset for a profit. The government will make more as a revenue share agreement than they would running it by themselves. It’s positive for jobs, it’s positive for most. It’s maybe .8% on GDP, to Larry’s earlier point. It’s more positive for the consumer and money in their wallet than anything else.

Gillian: Larry, same question posed to you, but also do you think it favors public versus private investment in infrastructure?

Larry Antonatos: Well, let me answer the question in a slightly different way, rather than focusing specifically on Trump policy, let’s talk about why private capital, public company capital does come in and replace government capital. It’s because governments don’t have the capital, governments are in debt. And very specifically to the municipal bond point, if a municipality has a low credit rating and their cost of capital in the municipal bond market is higher than the cost of capital of a well run public company, that well run public company can actually acquire that asset, run that asset, that airport, that toll road, more cheaply than a government can. And we are seeing a number of governments in the US, municipal governments, city governments, that are financially stressed. And we have actually seen in the past 24 months, the first airport in the US that was privatized, and that’s San Juan, Puerto Rico. And the reason for that is financial distress in San Juan, Puerto Rico.

Gillian: And ever in [inaudible] is praying that that happens to our top three.

Larry Antonatos: So when investor capital moves in, I think about it as a three-legged stool. There are three constituents; there is the investor, in my world, that’s the public companies. There is the local government and there is the consumer who is using the services provided by that infrastructure asset. And it’s important to note that those consumers are also voters. And all three legs of the stool need to be solid; everyone needs to feel that they’re getting a good deal. The investors need to earn a good return, the government needs to sell the asset or lease the asset on a long term basis at an attractive return for the government. And the citizens, who are the voters, need to feel like they’re getting good value in terms of quality of service. Now, if the price goes up, but the quality of service goes up, people are still happy. And we need that to happen on a consistent basis over and over, all three constituents happy, to make privatization of government assets more common in the US than it is.

Gillian: Okay. And interesting, the three-legged stool is an interesting visual to think about the forces at play there. Maxwell, I’m going to kind of shift over slightly, we were talking about energy a little bit earlier, particularly in the context of pipelines and MLPs. But taking a step back from that, the OPEC Vienna ruling late last year, obviously we saw that production was cut out of OPEC and some non-OPEC countries. They’ve reached a strong level of compliance, but now an extension of that cut is hanging in the balance. What’s your outlook for oil prices in 2017?

Maxwell Gold: Yeah, certainly. So we see oil prices in particular globally in the range of about $40-55 per barrel. That’s pretty much in the trading range of where it’s been in the past 12 months. And your key driver for that, where we’ve seen a bit of a pick up so far in oil prices this year has been the compliance of OPEC nations with their stated production cuts. That’s partly to offset the fact that we’ve seen an increase of US drilling oil, shale and gas, rig count here in the US to sort of meet what has been, a recovery in prices after a collapse in recent years beginning in 2014. And overall we think we see the US as being that marginal price setter or marginal price driver for the overall market. But where we see overall global surplus which has been built up since 2014, we’re beginning to see inventory drawdowns coupled with production cuts, should see beginning to support prices towards that higher end of $55 per barrel in the second half of the year, key to that as you mentioned really is where is OPEC going to stand. They historically have not been very complaint with their stated production cuts. So far they have been, but that’s been primarily led by Saudi Arabia, has gone above and beyond its stated production cuts, whereas the other OPEC nations have still yet to meet their benchmarks. And so we’re expecting an upcoming meeting in May, I think that will, you know, most likely point to signs that there will be further extension cuts to try to further support the overall market. But with a higher price we may see more oil rig increases, more US shale, oil and gas production in North America, you know, meeting market demand for higher prices.

Gillian: Saudi Arabia’s overachievement surely related to the [inaudible].

Maxwell Gold: That might be part of it, I think so. But I’m not going to speculate on that, but certainly we see that oil is a key commodity for Saudi Arabia as well as other OPEC nations. And what they’re really recovering from is sort of, you know, record low prices of recent years.

Gillian: I’m going to move our conversation from macro to the opportunity set and Larry and Ed, I’m going to start with you. Edward, to help us understand the universe of infrastructure assets, public versus private, for anyone that may not have been interested in this market but is hearing all the free marketing as you have heard it from President Trump, and is now interested in entering.

Edward O’Donnell: I mean look at public versus private; you might frame it around the risks that you would take on. So in private infrastructure, Brazil, India, China for example, you have transparency risk, explicit leverage, execution etc. There are meaningful risks there, and liquidity is obvious, for which you could be compensated. In listed infrastructure, the assets are more mature. Most of these risks have gone away. This isn’t garage band, this is Muzak, very stable cash flows, mature brownfield assets. One of the key risks is actually public debt; the volatility of borrowing becomes a pricing mechanism, that’s a risk in this space. The other thing is where you can invest regionally, and what’s publicly available. In listed infrastructure there is kind of a global constraint. In North America, the energy renaissance is on sale, not so much in Europe. But in Europe, transportation is also for sale. In Asia we look at more portable water in China and some other things. So the global opportunity set varies according to what’s publicly available.

And also there’s a difference between what we would call pure play and non-pure play. So in listed infrastructure you might have 600 names that are publicly available, that call themselves infrastructure, like Caterpillar for example. But when you look at pure play where 70% or more of the operating cash flow comes from infrastructure, north of that number you’re buying an asset; south of that number you’re buying a theme. You’ve cut that to 200 names, pure play. So they’re publicly held securities but they’re really an infrastructure asset. For us, that’s where you get the stable cash flows, the low volatility; it’s a portfolio of monopolies. End users have growing demand for this stuff; you are the only asset in town, to meet it. One client called it the Shrek Portfolio. People will pay that toll, for example, so there are constraints where … depending by where you’re investing in the world. And some things are still private, whoever subsidized the input in labor cost to build that asset hasn’t recouped it yet, or maybe they haven’t seen pressure on the balance sheet, where we have in the developed world. So it remains a private asset, so there are differences in risks when you go public to private and also some kind of regional constraints globally.

Gillian: I think the Shrek Portfolio should now be adopted as a technical term, that’s an excellent way of putting it. Larry, how would you help someone understand who’s coming into infrastructure for the first time, the universe and public versus private?

Larry Antonatos: So infrastructure is an asset class, very much like real estate in terms of the investment benefits it provides, portfolio diversification, inflation protection, long term capital appreciation and very good current income. And what we see is that the real estate business is much more mature, much more widely invested, much more widely held by retail investors in particular than infrastructure. Almost everybody has had experience investing in real estate. Most people we speak with are having their first experience now, investing in infrastructure. So with that in mind, think about the scale of the real estate market, which most people know, public real estate companies are roughly $1.5 trillion in market cap, roughly 500 companies all around the globe. If you think about the public debt market for real estate, it also is about $1.5 trillion. The infrastructure market is almost identical in terms of size and global distribution of companies and debt and equity. But fewer people in the US have actually been accessing the market. So what I tell people is if you understand the real estate market, the investment benefits you get there, you have a real head start in understanding infrastructure. It’s a very large market. Both markets are large, both markets are liquid, and both markets offer many opportunities for individual investors.

Gillian: Are public and private infrastructure performances correlated?

Larry Antonatos: I will tell you that if you look through the cash flows, to take a simple case. You could have a major infrastructure asset like London Heathrow Airport; its largest owner is a public infrastructure company, Ferrovial. They own 25% of London Heathrow. The other 75% is owned by a mix of sovereign wealth funds and infrastructure private equity funds. They own the same asset, they own the same cash flow, in the long run whether you’re in a private fund or a public company, you will get the same return. What you don’t have is correlation in the mathematical sense because private funds tend to be valued once a quarter on appraisal basis and public companies are valued every day in the stock market. So any move in interest rates or political risk, event risk is reflected immediately in the stock market. It takes a little bit longer in the private market. So what we see is that the correlations are actually, even though the long term returns theoretically should be the same, if the cash flows are the same, the returns should be the same. They can’t be two different. It’s actually very attractive to build a portfolio that includes both public and private because the correlation of public real estate to private real estate is about .5. The same is true on public infrastructure versus private infrastructure, the correlation is about .5. So blending them together in a multi asset portfolio gives you that free lunch that you get from diversification.

Gillian: And would you echo that?

Edward O’Donnell: You know, if you torture the data sufficiently it’ll confess to anything. So if you look at the correlation between public and private real estate, what we did is we adjust for market, market timing and leverage. And we actually saw between listed and private on infrastructure the one year rolling correlation was .78, the three years, .91, lots of caveats with that. The infrastructural benchmark on the private side with the longest track record is Australia. You have to adjust for currency etc. On the real estate side we also saw making adjustments for market to market timing in leverage; we saw a correlation between public and private at .8. So that infrastructure as in REITs, we would agree, you’re getting the liquid equivalent of something private, which is fantastic. You don’t have to take on liquidity risks that are accessed to that very attractive return stream. And real estate infrastructure do have a lot in common, they’re both capital intensive assets, there are a lot of similarities. Where I would beg to differ a little bit is the major differences in real estate, there’s always this third rail of the private market to correct you. So if you have a REIT trading at a significant discount to NAV, someone can unlock shareholder value. There’s constant competition for price, where we are today, you’ve got an office building next to an office building, a hotel next to a hotel. And if the price of concrete rises they can’t pass it on. You can go two blocks away and get an option. But in infrastructure you don’t build power lines on top of power lines or an airport next to an airport. So the lack of price competition differentiates the two asset classes in a meaningful way.

Gillian: I’m going to shift our conversation a little bit, and Maxwell, I’m going to come back to you, we talked a lot about Federal Reserve policy, but if we look at global monetary policy at large, we’re still seeing a very accommodative environment in many parts of the world. How does global monetary policy end the kind of coinciding currency volatility impact metals? We’ve already talked a little bit about the flight to safety with gold.

Maxwell Gold: So, certainly, I think that where we’re seeing a bit of an easing still is within Europe, within the UK, as well as Japan. The real only [inaudible], you know, tightening Central Bank has been the US and The Fed. And certainly they’re sort of looking to be, you know, very steady in terms of how they’re tightening. And our expectation is for about three hikes this year, which has been market consensus going into 2017. And overall the impact of how that’s impacted for, you know, currencies in particular is added volatility, if you look at the GBP last year with the exit, with Brexit, obviously record lows are hitting on that front. But you know, where I think a lot of questions have been is really the dollar. The dollar saw a strong rise following the election; they were leading up to the December hike last year by The Fed. And we saw a similar path where following the hike we do see a bit of a pullback on rates on the dollar, you know, until we get back to the next meeting, you know, for example, a couple of weeks ago in the March hike by The Fed, we saw a run up recovery of the dollar back to those, you know, to similar highs, but following the decision to hike we see the dollar and rates fall back again. And overall we’ve seen, you know, precious metals move in the opposite direction, particularly gold. And where we think that the dollar this year is going to be is pretty much range bound.

We’re sort of are at the higher end of that range where we’ve seen, but our expectation isn’t for the dollar to see another 22% appreciation, which is where it’s been since really 2010 and particularly for mid 2014 where it’s had a strong run up or appreciation. Where we expect the dollar is most likely going to be range bound, and so far this year it’s fallen back a couple of percent down, about 2-3%. And that’s been to the benefit of gold, of silver, of other precious metals, and particularly where we’re seeing that is a further benefit is in the local producers. So when we look at mine productions such as gold miners or silver miners, when their local currencies become weaker relative to the dollar, that lowers their cost. And meanwhile the revenues are priced in dollar terms which helps expand their profits, increase their margins. We have seen a bit of an unraveling of that beginning last year. And I think that’s also supported prices for the overall outlook of gold and silver in particular.

Gillian: Among the metals that you’re currently studying, do you see any particular supply shocks or surpluses coming up in 2017?

Maxwell Gold: So I think the most fundamentally attractive metals, actually one that many investors have probably never even heard of, it’s called palladium. And it’s primarily used in a catalytic converter for gasoline engines, essentially helps reduce emissions and helps reduce pollution, increase efficiency. And where we’ve seen that is it’s gone on almost seven years of persistent supply deficits. The majority of its supplies concentrated equally between South Africa and Russia, at about 35/40% each, that’s about 80% of overall supply. Meanwhile you’ll further emission standards, more focus of air pollution globally has spurred demand for more efficient, less polluting cars, which is, you’ll spur the demand for palladium. Additionally, overall global auto sales, particularly in China due to recent tax incentives last year, has helped spur overall auto sales, which has been increasing demand for palladium. And so far last year was actually the top performing metal, up about 20% followed by silver at 15 and then gold. And once again, so far this year, palladium is leading the way; it’s up about 15%. And we’ll likely see that be more reactive to more industrial production and more industrial cycle factors as opposed to say demand for a safe haven or demand for hedging, similar to gold in its role as a traditional defensive asset.

Gillian: You mentioned China’s role in the rise of palladium, are you thinking at all about the growth perspective for 2017? Are you worried about it or can it stay pretty much where it is and still see outperformance?

Maxwell Gold: So I think that where we’re seeing that is we’ve seen record auto sales in China. But the other factors that, you know, the US is also a big market for gasoline engines and cars. There’s not a lot of focus on electric vehicles, but overall they make up less than 1% of the global fleet. And where we’re seeing that further demand of, as we see, a recovery of the global economic cycle, increase of GDP globally, that goes hand in hand with increased auto sales, with increased GDP per capita as people begin to become a little bit more wealthy, they’re looking forward, you know, to upgrade their cars as opposed to say, you know, dealing with the existing car for a little bit longer for another year.

Gillian: Okay. So palladium’s one to watch. Larry, coming back to you, we’ve talked a little bit and discussed perhaps what the infrastructure policy of President Trump will look like. But as Edward said earlier, he’s provided a lot of marketing for the asset class. I’m curious to know how you’ve seen asset flows change in infrastructure and even real estate, are you worried about capacity overcrowding?

Larry Antonatos: We have seen increases in interest in infrastructure over the last six months. And we are not worried about overcrowding or capacity. The market is large and liquid, as I said it’s about a trillion and a half for each equity and debt. So we have no problems there.

Gillian: Okay. So both are looking good, even if President Trump goes ahead with some of his policies?

Larry Antonatos: Even if he goes ahead with some of his policies I do think that what actually happens with those policies is if assets move out of government hands into public company hands, the market cap of the public company gets bigger because the public company now owns a new billion dollar asset. So it really does, the market expands as investor capital comes into this space. So it’s all good.

Gillian: Okay, perfect. Edward, same question to you, how have you seen it change?

Edward O’Donnell: Couldn’t agree more, I mean you look at the universe for REITs or listed infrastructure, they’re both about 1.5 trillion. So when you think about capacity, why would you close a product? Two reasons, one is liquidity. As a crude yardstick, if you’re 3% or more of your investment universe you start to worry about your ability to trade fairly. We are some of the biggest managers in this space and we’re not at that limit yet. And also that base effect is growing. The other reason you close a strategy is alpha potential. So if you had a billion dollar pipeline, but you saw your alpha going down, you close because that’s your reputational capital, it’s your greatest asset. We don’t see a threat on either side. Liquidity remains abundant. Each of us is one of the largest managers in our space and we’re less than 3% on liquidity. And the alpha generation from both teams has been quite strong. It’s a very inefficient asset class; it remains a bit of a wild west. So that gap hasn’t closed yet, there’s plenty of runway for alpha.

Gillian: Let’s get a little more specific on the opportunity set and infrastructure. Larry, I’m going to take it back to you. US and globally, where are you seeing the most interesting sectors and regions right now?

Larry Antonatos: So I think the sector that is most interesting now is transportation infrastructure. We think about…

Gillian: Globally?

Larry Antonatos: Globally, we think about a few buckets on by asset type, utilities, energy infrastructure, which is pipelines, communications infrastructure and transportation. There are good opportunities in every sector and in every geography. But I would say that most interesting right now is transportation. In particular one driver is that in the US the transportation infrastructure is very much in need of investment. And transportation infrastructure is still principally owned by the government in the US. So there’s just more opportunity for it to move into public hands, that’s one reason. A second reason is that as the economy does accelerate globally, transportation assets are actually more leveraged to global growth, because there are more passengers flying on planes, there’s more cargo moving through the ports, there is more cargo moving on the rails when the economy is growing rather than when the economy is shrinking. So that is one broad area that we are very positive on now.

Gillian: And any particular region that might be interesting aside from the United States?

Larry Antonatos: There are opportunities everywhere.

Gillian: Edward same question to you, what’s a really hot opportunity set for you right now?

Edward O’Donnell: We would agree, we also like transportation. But I mentioned earlier communications and cell phone towers have been quite positive. Energy midstream, after a correction has done quite well. I mean you had a run up because any time policymakers influenced capital markets, well, it’s backwards day for us all. Like, people are looking for total return from bonds and income from equities. So you saw this rising tide lift our boats in MLPs and then it dropped. You know, Buffett said, “When the tide goes up you see who’s not wearing a bathing suit.” So we had a correction in energy. That still looks attractive. I don’t know that the downside risk is priced out, right. Your target price on oil, I’m sure there’s some volatility around that assumption, so we’re still attractive there. Utilities can be relatively attractive unless interest rates rise. You know, UK water held up really well, even on a currency basis during Brexit. So there are utilities that can be attractive on the merits, investors tend to oversell duration risk too much and too early. We still like utilities, we like water, and for example, I agree more about transportation, that’s a terrific opportunity set. We’re marginally selective in energy. I don’t think we’re overweight, but plenty of stock picking opportunity.

And in regions there’s plenty, globally well, we tend to focus in the developed world, emerging is part of our opportunity set. But we would need something as a mature asset that’s a publicly held security. We’d need to have confidence in the financial statements, not always the case. I’m married to a Brazilian when I say that, but also you have to think about the liquidity and the borrowing cost. You know, you mentioned The Economist, turn to the last page of The Economist, look at the borrowing costs in some those parts of the world, it’s high and volatile. And in listed infrastructure that borrowing cost of public debt is the pricing mechanism. It’s the most volatile input to NAV, so as a result we tend to be well underweight emerging due to liquidity and transparency and the trust and the cash flows, we tend to focus on developed where there’s plenty of opportunity.

Gillian: Okay. So interesting group of ideas there, Maxwell, I’m going to tee up a graphic that I saw in a recent Bloomberg article, and it has to do with how the Trump trade has impacted base metals. Now, this article made the argument that the US is not in an early enough stage of national development to generate big waves in these base metals. And so the question is, is the driver the rest of the world or Donald Trump, what is your thought for base metals coming into the latter half of 2017?

Maxwell Gold: So certainly, I think the biggest factor we’ve seen in base or industrial metals so far post election has been the run up in prices primarily driven by speculation or an increase of futures position by investors. That’s not really been met on the fundamental side, if you’re looking about supply and demand. On the supply side we’re still dealing with oversupply, we really need to see that supply side destruction or pullback. And we’re beginning to see it as a lot of miners in the industrial space are reducing their capital investment, looking to slow down production. And I think that will help the overall balance with the overall trend of increased infrastructure spending, not just in the US, but I think more significantly outside the US, in India, China, other emerging markets where we’re seeing more of a translation into industrial led production to more consumer led production of building roads, increasing, consumer discretionary purchases, more automobiles, more practical appliances that are more heavily focused on aluminum as opposed to say copper. And so I think when you think about that we’re going to see more support over the medium term as the global growth story continues to persist. Short term we’re actually seeing peak bullishness in broad commodities. And part of that has been the run up in speculation in industrial metals. So over the very short term I think we might see a potential correction on the horizon, but overall the medium to longer term story certainly is very constructive for those industrial metals.

Gillian: Now, when we talk about metals, we’re not just talking about holding the physical metal, there’s also plenty of liquid opportunities. But sometimes we see a divergence between liquid and physical performance, so silver immediately comes to mind, physical versus the ETFs. Can you explain to us what drives those differences?

Maxwell Gold: So, certainly, if you look at that, the key driver for the prices that you would probably see on your Bloombergs or if you’re looking on a website, the key driver of spot or fixed is going to be primarily driven by the futures market and then the OTC market. So when you’re looking at the physical demand side, it may be a little bit more slower to pick up, okay, so what’s been driving the prices day by day is really investor expectations and speculation in those futures markets primarily. What wins out in the longer term is really the fundamentals, the supply and the demand that helps set the ceiling and the floor for the overall range of the medium and longer term. But if you look at it, for example, taking silver, a lot of folks are saying, “There’s no investment demand, or even gold there’s no investment demand.” A lot of people forget or overlook the fact that the majority of demand is actually cyclically sensitive in terms of it moves commensurately with increase of GDP, with increase of industrial production. Silver, 50% of its annual demand is actually tied to industrial applications, primarily electrical, electronics, as well as a growing source of demand is the photovoltaic or our cell or the solar energy industry, which is, you know, but it remains very much a bright spot for silver which is key in production of capturing and turning sunlight into electricity for these solar panels.

Gillian: I’ve siloed this conversation up until now, but I’m going to bring you all back together again, and Edward, I’m going to start with you, what are some of the main benefits of incorporating real assets into a larger portfolio?

Edward O’Donnell: Think about the challenge facing many investors today, the 60/40, 70/30 balanced portfolio. Ask the smartest person in that shop, what’s their projected returns, could it be about 4½/5%. If you’re lucky it’s 6. Then hang up, ask your clients, “What kind of return are you looking for in your portfolio?” The required return for an actuary in a pension plan or desired return for a different client profile, it’s closer to 7½/8. Now you have a 300 basis point gap, option number one, live with the lower number, that’s called career risk. So what investable capital market risks can you use to bridge that gap? Liquidity, if you can lock up capital for 10 or 15 years there are some fantastic opportunities in the private side to land for example to build pipelines, not many clients can do that. What else do we have? Maybe you can take on hedge funds, explicit leverage, liquidity, transparency risk and the fees. For a lot of our clients that’s not the most palatable option. Now we’re left with something that’s liquid, not necessarily a stock, not necessarily a bond, different enough, but I can sell it tomorrow. So you look at listed infrastructure securities. It’s a solution for clients living in a low nominal world in this new normal.

Don’t want to accept the 70/30 portfolio. Now, go back 20 years, you could long 70, you know, 70/30 portfolio, long growth, short inflation and make it, not today. You need that alternative asset to meet your liabilities, to grow the capital because you think about the nine boxes, right, core, growth, value, small, mid ,large, those are nine ways to make money on the upside. What about the downside? What about the fat tail risk. Now, that said, every investment committee, so if you’re living in the low nominal world and you can’t lock up money or take on those other risks, liquid alternatives, like real assets, where they’re generating meaningful cash flow, meaningful yield, strong return, reasonable volatility, are a wonderful solution for clients.

Gillian: Larry, would you echo the same sentiments?

Larry Antonatos: I agree. I also want to go into sort of the driver of the low correlation that you get, particularly with infrastructure versus other asset classes. And I think that goes to one of the benefits of being in these liquid alternatives is the low correlation, moderate correlation between these liquid alternatives and generic stocks and bonds. If you add into your portfolio something that is not correlated and that has good returns, you will increase the return of your overall portfolio and do that in a very attractive risk adjusted way. If you think about almost any business you can invest in, it’s governed by macroeconomics 101, supply, demand and pricing. The quantity of the good is going to increase with the … so the supply is going to increase with price and demand is going to decrease with price. And where supply and demand intersect that is the market clearing price. Almost every business you can invest in, operates that way, real estate operates that way. You have a lot of market participants, you have a lot of buildings, you have a lot of tenants. This building and the building across the street are good substitutes for the other, it’s a competitive business. Shift gears to infrastructure, supply, demand and pricing is completely different. And that’s why you get very low correlation, very attractive correlation. Supply of infrastructure assets tends to be governed by regulators, there will be one water utility in town. There will be one airport in town, period.

Demand for most infrastructure services is very, very steady. Every morning, whether the economy is good or bad we will all wake up and turn on our lights, brush our teeth and take a shower, check our iPhone first thing in the morning and 100 times a day. The transportation sector is correlated to GDP growth, so there is a little bit of cyclicality there. But the rest of the market is very, very stable, so you have very steady demand for infrastructure services. And then when you get to pricing, pricing tends to be regulated by the government also, alright. The government gives you a monopoly, but they regulate your pricing. And all in all that leads to a very stable predictable income stream that is uncorrelated or low correlated to GDP.

Gillian: Okay. So, please.

Edward O’Donnell: So to tease that a little bit further, where I would agree with Larry even more is think about what is one definition of an asset class? Does it move the efficient frontier? Both of our firms were early adopters in REITs and listed infrastructure, and to do something that didn’t exist before. Clients who have invested with us for several years said, “We’ve moved their efficient frontier.” It creates a new asset class.

Gillian: Maxwell, we’ve talked a lot about the benefits of real estate and infrastructure, give us a sense from the metals perspective.

Maxwell Gold: Yeah, certainly. So dovetailing onto these arguments I think that if you look at precious metals in particular as an asset class, they provide you really a unique low correlation to not just equities, but fixed income as well. I view them much more as a core risk management tool. If you talk about gold, silver, other precious metals, it’s a very poor rising topic, particularly as an investment, people either get it or they don’t get it, they love it or they hate it. And certainly I try to take that middle ground saying that the benefits by putting it into an asset allocation or putting my portfolio construction hat on for a moment, you can see that there are benefits of increasing efficiency. You are helping reduce risk and drawdown in those left tail events as well as you’re helping to provide new sources of factor exposure which is unique to your metals that they have that cyclical factor of jewelry, of auto demand, of industrial applications. And that countercyclical factor of investment demand which comes online, particularly when we see turmoil in the market, heightened volatility and drawdowns. And when you put those two together that creates that persistent low correlation over time to other asset classes, which has the benefit to the top line of the portfolio level. And if you compare that to other liquid alternatives, what’s unique about precious metals is that low correlation has certainly persisted in this post-financial crisis world.

Going back 30 years or so, you know, after every major event or systemic event of the market, we do see an elevation of correlations which come out of the peaks post that event, but it’s at a sustained elevated level. And certainly we’ve seen that in 2008, where your other asset classes may be a little bit higher equity correlation. The one exception is that precious metals, which have come off those high peaks from 2008 in terms of how they move along with equity markets, so they’ve remained a true alternative asset in terms of providing that low correlation persistently over time over a full economic cycle. And we see the benefits of, and you incorporate them within your asset mix.

Gillian: If I’m diversifying within my precious metals portfolio, do I want to mix up or hold the physical and liquid, the various metals base versus precious, what do you recommend?

Maxwell Gold: So certainly we think that the way to access the market and provides that low correlation is the physical market, whether it be gold, silver, platinum, palladium, I think that a diversified exposure, all four makes sense, anchored in old. But you know, a lot of questions come up, what about gold miners or some other equity exposure? I think those are viable investments but you should really allocate them from your equity allocation, not as a proxy for the precious metal space. Because if you look at the S&P for example, whenever we see a peak to trough pullback of 10% or more over the past 30 years, on average over those periods the S&P has been down 20% or so, miners have been down on a total return basis 7%, whereas the price of gold has been up 7%. So that’s a 14% return differential in a period when you want that downside protection. So I would say, miners and other equity exposures to access the precious metals market is viable, but take into account the proper risks that those are equities or those are debt and what’s unique about the spot price of the metals or the fiscal bullion market is really that cyclical and countercyclical capture that creates that low correlation over time.

Gillian: It’s a great point about the equities now, gentlemen, I’m going to pose a similar question to you. If I’m diversifying within my infrastructure and real estate portfolio, what am I diversifying across, is it regions, is it sectors? Larry, starting with you.

Larry Antonatos: So we invest globally. So when you have a global real estate portfolio or a global infrastructure portfolio, it is all around the world, predominantly markets, a small amount of emerging markets. There are a number of different property types within infrastructure: hotels, apartments, industrial, specialty property types like [inaudible] billboard companies, student housing. You can get some niche property types, so you do get a well diversified portfolio within real estate. You get a well diversified portfolio within infrastructure. And the way we think you really maximize your return potential and move your efficient frontier the most is to have all of the asset classes in your Real Asset portfolio. Don’t have only real estate, have real estate and infrastructure, have equity and debt, and if you can, have public and private. What we think on a public private basis, as I said, in the long run we believe the returns will be the same because the underlying assets and cash flows will be very similar. If you can find private investments that have very specific value add, maybe higher return, higher risk strategies that can really add some return to your portfolio. And you’d do that in a measured amount. With private you’re generally locked up for 5, 10, 15 years. But you can make some excess return if you pick the right manager and the right strategy.

You have an alpha generation by the asset manager working the physical assets very hard in a private structure. In contrast with liquid securities, what we do, we’re not working the assets, we’re trading the portfolio. We’re buying what we think is cheap, and we’re selling what we think is expensive. And that’s a different way to generate alpha. So having private alpha and public alpha, which are completely different and uncorrelated, continues to move your efficient frontier higher.

Gillian: Larry, talk us through some of the benefits of investing in a liquid real estate or infrastructure portfolio.

Larry Antonatos: We like investing across real estate infrastructure equity and debt. Within each of those portfolios, obviously we’re trying to pick the right securities within each portfolio, buying and selling, buy what we think is cheap, sell what we think is expensive. But if you have a multi asset class, real asset portfolio, you can actually add value on another level, through dynamic asset allocation. If real estate becomes expensive, you can reduce your allocation to real estate and buy more infrastructure. If you want to be more aggressive because the economy is growing, you can reduce your debt exposure and add to your equity exposure. Vice versa, if you want to be defensive, you want to add to your debt positions. So it’s great to have all these levers to pull from an asset allocation perspective, in addition to stock selection within each asset class.

Gillian: Perfect. And, Edward, lastly to you, how do you think about diversification within your infrastructure portfolio?

Edward O’Donnell: If you want to have a well diversified Real Assets portfolio you need to have public and private equity and debt. So look at real estate for example, in REITs you can buy hotels, it’s a lot harder to do that in private real estate. So you get access to things you couldn’t otherwise access. And it’s very important to stay diversified by region and by sector, we think that’s key, by liquidity. And also there are other ways to manage it, even diversity by duration risk. You think about the lease reset as a duration risk, so your hotel is a one night lease, your self-storage is a month, your apartment is a year, all the way down to triple net lease and specialty which is 20 years. You can manage around that. So you’re diversifying that exposure well, through the cycle that diversified portfolio should perform well, but you should also allow everything to compete for capital, public, private, equity, debt, infrastructure, real estate, in that bucket, what are my best ideas, let all of those sub-buckets per se compete for capital, that’s an optimized portfolio.

Gillian: Well, gentlemen, we’re at the end of our discussion. This has been super interesting. Thank you for taking the time to share a little bit of your thoughts on real assets. You’ve given us such a range of things to think about, both from a macro perspective and you’ve even drilled down into your best opportunities, so thank you. And thank you for tuning in. From our studios in New York I’m Gillian Kemmerer and this was the Real Assets Masterclass.