MASTERCLASS: Real Assets - November 2017

During inflationary periods, real assets act as a powerful hedge due to their capital appreciation and low volatility. As the global economy continues to grow and central banks alter their monetary policies, many investors are turning to this asset class for protection. What defines a real asset, how should investors construct their portfolios with real assets, and do investors have to give up any returns in favor of low volatility? In this edition of MASTERCLASS, four financial experts join Asset TV to explain the current opportunities within the asset class, and the best ways to diversify any portfolio with real assets.

  • Larry Antonatos, Managing Director and Portfolio Manager at Brookfield Asset Management
  • Matt Collins — Director and Head of U.S. Product at ETF Securities
  • James Clark — Portfolio Manager for Real Estate Securities, Global Infrastructure and Real Asset Income Strategies at Nuveen Asset Management
  • Jodie Gunzberg — Global Head of Commodities & Real Assets at S&P Dow Jones Indices

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  • 54 mins 56 secs

MASTERCLASS: Real Assets - November 2017 Gillian: Welcome to Asset TV. I’m Gillian Kemmerer. Real assets have long been used as an inflation hedge, prized for their low volatility and diversification benefits. But what defines the universe of real assets and where are the opportunities now? Today I have four experts joining me to tell us a little bit more the universe of real assets, so welcome to this edition of Masterclass. Right, everyone, thanks so much for joining us here today. Wonderful. So I want to start off with just a quick definition of what is a real asset, because there are some differences here. And I’m actually going to tee up comments to start from Jodie Gunzberg. She’s the Global Head of Commodities and Real Assets at S&P Dow Jones Indices. And she’s going to tell us what the benchmark considers to be Real Assets. Jodie Gunzberg: Based on surveys we try to gauge what would be the broadest set of real assets. And some things are pretty inarguably real assets, things like physical gold or farmland, timber, a physical property, those sorts of things have very high agreement. But we have to cut it off as an index provider where there is liquidity and pricing availability so we’re able to construct the index and [inaudible] a level. So the liquidity and the pricing availability is where we draw the line. And again then we can include the listed property, infrastructure, natural resources, inflation bonds and we also can add commodities futures. Gillian: So, Matt, I’m going to pose this question to you. How does ETF securities define the universe of real assets? Matt Collins: Sure. So if you think at its highest level at a basic portfolio construction level, what is an asset that acts different than your equity and bond allocation? If you think about the equity market you price those assets based off of its risk level and potential growth. That’s how you sort of arrive at its price in the equity market. A real asset is different, you price it essentially on its tangible value. So right there you have sort of tangible assets, you know, as Jodie mentioned, gold, silver, oil, wheat, those type of things, their proximity to the scarcity of that commodity or some other type of tangible asset like real estate. When you’re tied to supply and demand that really sort of gives you the profile of a real asset, but most importantly it looks and acts different than the rest of your portfolio. Gillian: Okay. So that’s a succinct definition. And then when you think about let’s say something like an inflation bond that’s often classified as a real asset because of its inflation hedge property. Is that something that you would consider to be a real asset too? Matt Collins: You know, we typically manage precious metals and commodities so we would say no. But it serves the same general role. So when you look across these assets whether it’s, you know, real estate as an example, or commodities, people are trying to protect against inflation. And you know, TIPS or inflation, you know, linked bonds serve that role at the most obvious level, right. And we’ve seen a tremendous amount of cash flow into TIPS products, primarily from retirees looking for some type of protection, maybe because it just says it right there on the label and it’s easy. So it serves that purpose but I don’t know that we would necessarily say it’s a real asset. Gillian: Okay, got it. Larry, how does Brookfield classify a real asset? Larry Antonatos: Well, going to what you and Matt were just discussing, we would characterize TIPS as real return assets rather than real assets. And I think the phrase ‘real return’ and ‘real asset’ are used interchangeably. What we’re focused on is physical assets, so real assets that have a combination of inflation protection, income and capital appreciation. Another thing we’re looking for in the real assets where we invest is visibility of income because what we’re trying to achieve is all of those investment objectives with a somewhat lower volatility due to the stability and predictability of the cash flows. Gillian: So then how would you relate real asset and real return assets? Larry Antonatos: So real assets typically do provide real return or inflation protection but that’s not the only thing they provide. They also provide significant coupon and significant capital appreciation over time. Gillian: Excellent, thank you. And, Jim, how do you define it at Nuveen? James Clark: Yeah. We focus on real estate and infrastructure almost exclusively. And we would define it as a location specific hard asset that garners a fee for use through a long term contracting concession. Kind of along the lines that Larry just mentioned in terms of a recurring cash flow stream that has a contractually based construct that governs the economics of the asset itself or in the case of real, a lease. So it’s really about our consistent visible cash flow stream on an asset that’s really not going to get up and walk away. Gillian: So overall those inflation bonds wouldn’t necessarily fall into your bucket? James Clark: Not with anything that we do, no, because we’re going to require that it is a physical asset rather than a financial asset, at least at the underlying asset level. It’s companies that are managing these physical assets. So it’s not a private investment or a direct investment in a building per se. But it’s companies that are owning and operating those physical assets. Gillian: Perfect. That’s very helpful in defining the universe that we’re talking about today. Let’s go a little bit into the current macro picture. And, Larry, I’m going to start with you. I believe when we spoke last you called it the Goldilocks view of global growth. We see strong valuations. We’re waiting to see kind of what happens with corporate earnings this week. We’re obviously seeing synchronous global growth. Could this continue or are we coming toward the end? Larry Antonatos: Well, if I think about the macro factors of economic growth, inflation and interest rates, I think we are in a Goldilocks environment. And I think we’re going to continue to stay in a Goldilocks environment. I think those three macro factors will drift up over time, not dramatically higher, but will drift up over time. And that is a Goldilocks environment. What I am concerned about is the valuations that you mentioned. I look at valuations of broad equity markets and broad fixed income markets. And things seem somewhat rich. Perhaps those levels of valuation are appropriate if the Goldilocks environment will continue. I’m just not convinced that we won’t have some volatility to interrupt that Goldilocks environment. One of the things I’ve said over the past few years is it feels like the economy globally is two steps forward, one step back. I’ve improved my view recently and I think we’re more in a three steps forward, one step back. So it’s an even better Goldilocks environment. Gillian: Now, when you mention this potential volatility, what are some of the underlying causes that you have identified as potential catalysts? Larry Antonatos: You know, I think the standard things people are concerned about is geopolitical risk. It could be actioned by central banks that perhaps don’t have the intended effect. But I think the real wild card is what if people simply get a little concerned about valuations and they go sideways and then they fall. Gillian: And they’re calling it the least loved bull market in history, so certainly a plausible scenario. Jim, when you look out at the macro picture what do you see? James Clark: Yeah, a lot of the same things really. And we’re pretty deep and late into the cycle if you consider eight to nine years of an expansion, right. So that puts us a long way in. But given the easy Central Bank policy across the globe, not only here but in Japan and Europe, they have certainly provided a ton of liquidity. And it’s really I think been the tailwind for financial assets. And even though we’re later in the cycle here, and we’re talking about tightening a little bit in terms of what The Fed is doing, it looks like it’s going to be very, very measured. And you don’t see a lot of inflationary forces out there that would call for demonstrably higher interest rates. And if that’s the case then that’s going to be supportive of the valuations that we have, and the economy continues to move forward with good unemployment numbers and, you know, a lot of times better than expected growth, especially in Europe and even in Japan, so. Gillian: We’re in the midst of an interesting race for a Fed Chair, it’s not really a question of who’s in the running, it’s more like who isn’t. It seems like absolutely everyone is in the potential running. Are you worried at all about leadership changes there changing the picture? James Clark: That could have an effect at the margin, probably at the inception of that person’s tenure. But really it’s going to be the market forces that determine the longer term rates. It’s the 10 year treasury that’s going to be most concerning to us in terms of valuation and discount rates and what your present value of cash flows are rather than what The Fed Funds rate is. So it’s more, I would think, theater than, you know, less what we’re concerned about than probably long term rates. Gillian: Excellent. And, Matt, how do you think about the macro picture right now? Matt Collins: Yeah, for us, there is volatility out there, right. The VIX is at a record low. The equity market is priced, you know, a fairly low level of volatility. I think what’s interesting is, everyone knows that there’s volatility out there. The problem is the type of volatility that exists, you don’t know how to price into a traditional equity. So you know, if you think about, you know, a congress that hasn’t acted and seems to not be able to act, a president who, you know, makes a lot of claims but is coupled with a congress that’s sort of unlikely to make things happen, along with sort of, as you mentioned, geopolitical risk that’s out there. Whether it’s in, you know, Asia or the Middle East, it’s out there. It’s difficult to take all of that and price Apple. So I think there is volatility out there but it’s not being priced into the equity market. But you are seeing pockets of interest in other asset classes, real assets, from investors that are worried about it, but don’t know quite what to do with the rest of their portfolio. Gillian: So for an example for anyone that’s listening and trying to figure out what exactly this would going to look like, is it investors going to gold when we see missiles going over north Korea, what does it look like? Matt Collins: Gold, precious metals in general have had a steady incline. Typically when you have those types of risks out there you see peaks and valleys. And that’s what you don’t want, you don’t want to invest here and sell down here, which to us means there’s a small pocket, particularly of institutional investors and international investors that have been slowly building up their allocation to precious metals in anticipation. But we haven’t talked to anyone that’s necessarily overweighting the asset class because you know, the fact of the matter is it’s hard to pull out of a market that’s doing well in the equity market. So it’s just been a gradual sort of incline up. Gillian: Now, you touched, Jim, on inflation and I want to come back to that picture for a moment. The Federal Reserve is having a really hard time stoking the coals. Do you think that it’s something that could pop up and surprise us? I heard Liz Ann Sonders this morning on Bloomberg saying that she’s a little afraid that everyone doesn’t think inflation is coming and therefore perhaps it’s going to surprise on the upside. What do you see coming down the pipeline? James Clark: It’s kind of hard to paint a picture for demonstrably higher inflation given that you haven’t … I mean we’re at 4.3% unemployment. And you really haven’t seen any pressure from a wage standpoint. And you have the disruption from ecommerce and things like Amazon, that’s cutting prices. You see things like AI, you know, impacting the service sector and the financial industry in terms of keeping a lid on wages. So it’s hard for me to see a lot of inflation out there. And I think that’s probably what the bond market is telling you and what global rates are telling you is that it doesn’t appear that, you know, there’s a lot of it coming. And so with that, that would kind of call for continued lower interest rates and support the valuations that we’re at in the market right now. Gillian: So technology, digitalization driving down inflation is more of a secular change than a cyclical one? James Clark: It seems like it, yeah. Gillian: Matt, what about you, what do you see in inflation? Matt Collins: I mean we see some pick up, we see some signs, we see some interest, particularly in commodities more linked to inflation. So you know, [inaudible] as an example. We see some signs that that’s picking up, but it’s just not, it’s just not there. Gillian: Okay. And, Larry, what’s your inflation picture right now? Larry Antonatos: As I said earlier, I think it’s going to drift modestly higher, but not dramatically higher. I do think it’s appropriate for the Federal Reserve and other central banks to be raising short term rates. They want to be ahead of a spike in inflation rather than behind it. That’s one reason. But I think more generally if the purpose of lower rates is to create liquidity when the market’s under a lot of stress, it doesn’t feel like the market’s under a lot of stress today like it was in the global financial crisis. So it’s something appropriate for all central banks to be less accommodative. So I am in favor of raising short term rates. I am in favor of shrinking the balance sheet of the US Fed. And I think the European Central Bank will be doing the same things. But a year, 18 months, two years behind the US because our recovery in the US has actually led the European recovery, we’re definitely late in cycle in the US recovery. It hasn’t been an incredibly strong recovery but it has been very extended. And the European recovery is a little bit behind us and it looks like it’s definitely accelerating now. Gillian: Well, I heard the analogy that it’s like keeping the patient in the trauma room after they have stabilized, it’s time to take the economy off the life support if it doesn’t need it. Jim, let’s talk a little bit about the role of real assets in a portfolio, particularly right now we are in a low inflationary and low volatility environment. So where do you see them fitting in? James Clark: A lot of times people look at real assets as an inflation hedge mechanism. And that’s why they want it in their portfolio. And it makes sense because at the real asset level, right, if a replacement cost is going up because the economy’s doing better and you have higher cost of labor and higher cost of materials, then replacement costs goes up, the value of an already constructed real asset is going to appreciate. Similarly on the cash flow side for a real asset with a lease, it’s got rent escalators in it. And in infrastructure a lot of times you have contracts that are tied to CPI. Well, a lot of people forget about those, we’re talking about very long lived assets that have very long term lease or concession, sort of agreements with the government, and a lower interest rate is your discount factor. And so that’s going to raise the present value of cash flow. So when you look at returns on real assets over the last several years, even in a sort of disinflationary environment, I would argue that the performance driver has been a heavier hammer to throw in terms of a lower discount rate, which has caused the value of those longer term assets to appreciate. So it actually works potentially better in this sort of environment, even than if there was a little bit of inflation. Gillian: And while we’re talking about performance I want to mention volatility for a second. Real assets have always kind of had that low vol profile, but do you find that investors have had to give up any returns in favor of low volatility? James Clark: If we look at infrastructure that’s more of a low vol profile relative to a global equity opportunity set. And if you look at capture ratios of an index for instance in infrastructure, over time it has lagged global equities, but not by very much. The upside capture’s in the 90% range, whereas the downside capture by virtue of the sort of monopolistic position it has in the marketplace, those recurring cash flow streams, the downside capture and beta characteristics are a lot lower. So there seems to be a positive asymmetric sort of return profile for infrastructure. Real estate’s a different animal, that’s a lot more cyclically exposed, it’s a lot more sensitive to the economic cycle, job growth and what the economy is doing. And so you get a little bit more volatility there, which is why we kind of argue for the implementation of both in our portfolio because they act a little bit differently. Gillian: And, Larry, when you look at the macro environment that we just painted a picture of, how do you explain the role of real assets in a portfolio? Larry Antonatos: We’re looking for three investment objectives with real assets, it’s income, capital appreciation and inflation protection. And in a low inflation environment the nice thing about infrastructure, real estate, both equity and debt is they do provide that coupon for income. And the equities in particular provide capital appreciation. We’ve done a lot of work in inflation environments and the performance of real estate and infrastructure versus asset classes that have higher inflation data, commodities, natural resource equities. And what we have found is that due to the mix of characteristics that Jim described, of some cyclicality as well as some defensive characteristics. Real estate and infrastructure can actually outperform global equities when you have inflation and they outperform global equities when you don’t have inflation. So it’s not a one trick pony where inflation is necessary for good performance. Gillian: So no matter what happens, even if we are surprised, let’s say, we could still see some really great performance out of this asset class? Larry Antonatos: Absolutely. Now, it may not in times of very high inflation, real estate and infrastructure equities may not keep up with other more inflation sensitive asset classes. But we expect them, based on history, to outperform global equities, because that’s what they have done in the past. Gillian: Perfect, and Matt, how do you explain the value add of real assets to your clients? Matt Collins: So I mean going across the panel here, we try to carve it up into two categories. When you look at your alternative bucket in your portfolio for real assets, one’s certainly you have capital appreciation, but you’re trying to protect against inflation. That’s where infrastructure, TIPS, broad commodities do well. The other is trying to improve the sharp ratio of your portfolio, meaning finding an asset class that can sort of smooth out your ride, so you have a better long term experience. That way if things do go sideways or down in your portfolio you can approach your clients and say that you were sort of protected from those type of events. Now, the precious metals category has characteristics that are pro cyclical. And we can, you know, talk about that later. But we do try to, you know, stress to clients to sort of carve out the alternative bucket to make sure that you are split between sort of your inflation protection but also sort of your volatility protection. Gillian: And when you talk about the sharp ratio, is it sort of rewarding for every unit of risk that you’re taking? Matt Collins: Exactly. So if you think about your portfolio, you know, traditionally just say 60/40 stock bond or if you just shrink that a little bit and add 10% to alternative, what you want is a return profile that looks different than the rest of your portfolio. That way when the rest of your portfolio isn’t moving in your direction, your return profile isn’t as … it doesn’t take as big of a hit. So that way, you know, the amount of return you’re getting per level of risk over the long term is much improved. Gillian: Okay. So we’ve painted a picture of the macro elements at play. We’ve talked a little bit about the universe of real assets and how they fit into a portfolio. So let’s dive further into the opportunity set. And we have a varying set of perspectives here. So I’m excited to get started on this. I’ll start with Jim and Larry and Larry, if you want to take this first. Tell me a little bit about what the listed marketplace looks like and what is the opportunity set right now both in infrastructure, real estate, whatever you’re trading at the moment. Larry Antonatos: Our focus is on real estate equities, infrastructure equities and debt in the real asset spaces, which is a little bit broader. It’s real estate, infrastructure and natural resources debt. If you look at the equity asset classes, real estate equities and infrastructure equities, they’re each roughly $1.5 trillion in global market cap. They each have roughly 400 companies. They are concentrated in developed markets. And each benchmark for real estate or infrastructure is roughly 50% in the US, 50% ex US, which is actually very similar to the global MSCI World Index. So that’s what the benchmark looks like. It’s a large liquid benchmark. And we consider these to be alternative asset classes. They’re represented in broad benchmarks. And what people frequently do is they will over-allocate by adding a real estate or an infrastructure strategy or as Jim, mentioned, strategies that do both to their portfolio to get increased exposure to real assets. In the debt market the real estate, infrastructure, natural resources bonds represent roughly 50% of the corporate bond market. So again it’s a large and liquid bond market. What we observe in the real asset bonds is that they have a lower default rate than non-real asset bonds. And that can be attributed to the defensive characteristics of many asset classes, particularly infrastructure. And if the bonds do default they have a higher recovery rate historically because there’s something physical for the creditors to attach to, it might be an infrastructure asset, a real estate asset or a mine. And so we like that risk return profile within real asset debt. Gillian: So we’re looking at multiple asset classes across the capital structure and diversifying geographically? Larry Antonatos: Yes. Gillian: Okay, perfect, Jim, how do you look at the opportunity set? James Clark: Yeah, similarly, the geographic profile from our portfolio perspective is a little bit broader I think than a lot of folks, where we try to fair out ideas that are non-US. In the US markets, especially in infrastructure it’s pretty heavily weighted in energy, utilities and communications by way of cell phone towers. The diversification that we like from the global marketplace is getting access to transportation assets like airports and seaports and toll roads, things that have been privatized and listed in the marketplace for investment. So we typically have anywhere between 20 and 28 countries sort of represented in our infrastructure portfolio and really like the fact that it is a very global universe. We think that can add some benefit. Gillian: And are you looking at private assets as well? James Clark: Only listed. Gillian: Okay, and Larry? Larry Antonatos: We have listed strategies and we also separately in another part of the firm does private asset strategies. But our conversation I think here should be focused really on the listed. And what we’re looking for with listed real asset securities, on the equity side we are really focused on companies that own and operate physical assets. Because what we want to provide to investors is a liquid tradable daily priced alternative to the identical cash flows that you would get if you owned a building or you owned a utility. Gillian: Perfect. Now we have the infrastructure and real estate point of view, let’s go to precious metals. What does the environment look like for this asset class right now? Matt Collins: We’ve been really pleased with the precious metals category. So if you just go back to 2016 that was a great year. If you looked at ETF flow, the top two or three products were gold products, just different gold products all getting a tremendous amount of flow. And that was primarily because of the volatility that existed in the market. But what we’re happy with is that it continued into 2017. We continue to see strong cash flow into precious metals. As a group they’re up about 12% year to date, which again in the precious metals category you want to avoid, like I said, the peaks and valleys. With that said there are some different degrees of success within the precious metals category. So gold and silver get all of the attention. But you also have platinum and palladium. Palladium this year is up 43%. Last year it was also up, I think, over 20%. So it’s continued to really strong rise. It doesn’t get a lot of attention, I would challenge you to find someone that knows or has heard of palladium. You probably won’t find them. Gillian: Our Asset TV viewers have because one of your colleagues was on our last panel discussing them. Matt Collins: That’s true. That’s true. We’re the company out there talking about it. But in terms of the palladium market what is interesting, you mentioned strikes taking place. In the palladium market, Russia is about three-quarters of supply. And the producers are really concentrated in Russia. What you have is sort of a limited opportunity for these producers to secure supply. They have a lot of their supply out on lease. So they’re trying to get as much supply as they possibly can. And there’s also a tremendous amount of hedge funds on the back of that. Those types of dynamics make these type of products different than equities and bonds. So we don’t recommend, you know, placing your bets in platinum or palladium or, you know, silver, gold, unless you really research this space. But when you combine all of those together it does have a pretty powerful impact over the long term. Gillian: Now, you mentioned that we’ve obviously seen some strength in the equity markets and also strength in precious metals. Are you surprised to see the two rising in tandem? Matt Collins: We are, yeah, typically you don’t see such a strong correlation between the equities. I think the S&P’s up 12/15% year to date, so are precious metals, almost to the same extent. You don’t see that very often. Now, if you think about gold, there is a tremendous amount of demand that comes from China and India in the jewelry market, so that helps the cyclical aspect. But again there’s a small community out there with a lot of money that continues to slowly increase their position. Gillian: So I want to bring the conversation back to Jodie Gunzberg, who I spoke with last week. And she’s going to tell us a little bit about how the S&P constructs their real estate benchmark. And then I’m going to tee up the weightings of that benchmark so we can talk a little bit about where you’re overweight and underweight within your respective asset classes? Jodie Gunzberg: There have been an increasing importance on independence and transparency. And until now many of the benchmarks in real assets have been either custom or maybe like a CPI plus S. And they don’t necessarily reflect the growth possible set of real assets instruments. So we try to construct this benchmark as a way to show what passive real assets can be. Gillian: Now, I’m going to pull up for you and all of our viewers at home, the breakdown of the S&P Real Assets Index components and weights. So actually, Jim, I’m going to start with you here, we’re going to pull up the benchmark at the moment. How would you necessarily put yourself overweight or underweight, not necessarily within the whole universe of real assets but within the ones that you’re looking at? James Clark: So the window into that would be the allocation that we have within one of our products that combines both infrastructure and real estate. And over time if you think of a rough 50/50 allocation between the two, we’re currently 70/30 in favor of infrastructure. That has a lot to do with the underlying fundamentals and growth at the cash flow level, relative, especially to domestic commercial real estate where you’re starting to see NOI growth begin to flatten out or decelerate in some particular areas. A lot having to do with the fact it’s a good problem to have, that a lot of the buildings are pretty full. If you look at occupancies, they’re in the high 90s in a lot of other real estate sectors, and so are property groups. So by virtue of that you don’t have the ability to have absorption or new tenants come into your building and have a two-pronged sort of growth rate from a cash flow standpoint of both rent increases as well as absorption. So within infrastructure and especially overseas, we’re seeing stronger underlying momentum and fundamentals. And for a lot of those reasons we’re more favorable on infrastructure currently. Gillian: Excellent. Matt, how do you look at overweight versus underweight even within your precious metals bucket? Matt Collins: Yeah. I mean just within the precious metals bucket we are typically the most constructive on silver. Silver, from a relative valuation to gold, but more importantly, silver is highly used in solar panels. About 50% of demand for silver is non-investment related, meaning sort of, again, pro cyclical type things. And given its sort of relative valuation we’re very constructive on that. And then more broadly speaking we have seen … well, in the commodity market it’s had a rough five years, from a performance perspective, from flows, people have been pulling back from commodities. But just in the last month or so we’re finally starting to see positive performance and cash flow into ETFs that cover broad commodities into that space, which to us is a sign of two things, one, potential weakness in the dollar or, two, again, as we’ve been talking about, a potential hedge against inflation. And that tends to be the folks that are leading that are institutional players. So that’s really what we’ve heard from clients. Gillian: So, silver right now is out first but when you look at gold, if we see some increase in geopolitical volatility for example, would you perhaps switch your weight a little bit? Matt Collins: Yeah, I mean the two tend to follow each other and silver provides that sort of extra beta to gold and it does it sort of in a delayed fashion. Gold’s always going to be everyone’s favorite, there’s just no way around it. You can educate as much as you want, but gold is where people are going to go if things break down. Gillian: Perfect. And, Larry, talk to me a little bit about what you’re overweight and underweight right now. Larry Antonatos: So we like the S&P Real Assets Index. We like that it is global. We like that it’s equity and debt and it encompasses all of the real assets, essentially market cap weighting. Relative to the S&P Real Assets Index, our multi asset class real asset portfolios actually have more equity and less debt right now. That’s partially due to our view on valuations. We look at bond yields as being … yield spreads treasuries being tight versus history. They have stayed this tight for years in the past, they could stay this tight now. But we look at equity versus debt, the growth prospects that we see, the rising interesting rates, rising inflation and we would tilt our portfolio more towards equity rather than debt. We would agree with Jim at Nuveen about preferring infrastructure slightly to real estate. We think that within the infrastructure market there is actually some potential to capture a lot of growth in the more cyclical components of infrastructure which are airports, seaports and toll roads. You know, as Jim mentioned, those are principally found outside the US, where a lot of transportation infrastructure has been privatized. So you can go to Europe and, you know, I can name a dozen airports that are owned by public companies. And what we observe in transportation infrastructure is that traffic volumes tend to grow or shrink at twice the rate of GDP change, so they’re very pro cyclical. And that’s not something you typically think about with infrastructure. You think about infrastructure as being slow, stable, secure, prices that move with inflation. But you can get a little bit of cyclical upside with the transportation space. The other thing that we like within infrastructure is energy infrastructure, MLPs, US Energy Master limited Partnerships as well as traditional C-Corp pipeline companies. Oil price was cut in half over the past three years. We are looking, spending a lot of time looking at the supply and demand and the pricing of oil because it does have some derivative impact onto the cash flows, the profitability of the pipeline companies. Most importantly what we like about the pipeline companies is that they’re very, very cheap. And that’s one way to get some extra return in a market when many things seem fully priced. Gillian: Well, I just read that the OPEC General Secretary is calling on the US to join the production cut party, so to speak. So if we do, do you think that energy prices will only continue to stabilize or does it not matter? Larry Antonatos: I don’t think that the US can join the production cut party in an official way like OPEC, because those countries are really dominated by national oil producers. Here in the US we have many, many exploration and production companies. And what we are seeing that we’re very positive on is that investors are sort of forcing those exploration and production companies to do exactly what OPEC is asking for. We want; investors want the exploration and production companies to focus on profitability rather than growth. And if they focus on profitability they will probably produce a little bit less. The price of oil will go up and that’s good for everybody. Gillian: Now, Jim, I want to come back to you and you mentioned that you were primarily interested in infrastructure at the moment. So can you talk to me about some of the trends that are driving supply in the infrastructure market right now? James Clark: Well, supply in terms of the overall opportunity set really comes from privatization in non-US. Some of the airports that Larry had mentioned as an example, aena which is a Spanish listed company has 42 Spanish airports and 27 some outside of Spain. And that’s a relatively recent market entrant in terms of a collection of assets that have been put into a listed vehicle and put on the exchange. So a lot of the supply in terms of investment opportunity set comes by way of additional privatization or additional listings of assets in the listed marketplace. In terms of where we’re positioned from a portfolio standpoint some of the things that we like in the United States especially, it really has a lot to do with technology infrastructure, due to really strong secular trends, I think of datacenters as an example. There, kind of back to Larry’s earlier comments a little bit questioning relative to valuation given how well they have done. But if you think about datacenters providing the server racks for the insatiable amount of demand that we seem to have for data, for enterprise wide solutions, for the Internet of Things, for cloud computing and so on, you’ve got a really strong demand and need for that sort of space. So it’s sort of a secular trend in terms of growth. And something similar in cell phone towers, you see something very similar there in terms of tower densification and the need for additional upgrades and new technology that’s placed on those towers. So technology infrastructure is an area where we see some of the best fundamentals, but would also echo the comments from Larry about the transportation space outside of the US. Gillian: Well, coming back to Europe we’ve seen a very rosy picture there. And of course everyone was talking about how cheap Europe looked compared to the United States earlier this year. Have you found that valuations have sort of tightened between the two? And are you expecting to continue to see a rosy picture moving forward? James Clark: They have a little bit given the outperformance that you’ve seen in that market relative to the US. But the other thing kind of goes back to what Larry had said about where we are in terms of depth, especially from not only an economic cycle but a tightening cycle and Central Bank activity where we still have a little bit lower perceived interest rate risk in Europe due to the fact that they are, you know, maybe a couple of years behind where we are in terms of policy there. And that should be supportive of equities there as well, plus you’ve got some upside surprise in terms of what the growth rates have been looking like in Europe. Gillian: Now, Matt, I want to come back to you for a moment. Can you talk to me a little bit about some of the misperceptions around the trading of precious metals, how they use versus how they perform? Matt Collins: I would say how precious metals are used are entirely different than how they perform most of the time. Every client that we talk to buys a precious metal in their portfolio typically gold, as we discussed, for event risk, and that’s about it. But if you look at the gold market, over 50% of its demand comes from jewelry, and the vast majority of that is jewelry demand from China and India. That’s an entirely different profile than event risk. That is a growing consumer, growing population, wealth elevation within that region that affects gold’s price. So if you think about that over the long term, that provides a nice stable floor to gold, again, as long as you’re not buying up here in 2009 or something like that, if you sort of shift over to silver. Silver tends to be much more volatile, a much more eventful ride. But, again, a lot of its use is industrial, not necessarily investment. I think investment demand is around 20% of silver. Investment demand is safe haven demand, essentially are people storing it away. Something being used in a solar panel is entirely different than playing some volatile asset class. And then shifting over to platinum and palladium, palladium as an example, 76% of its demand is as a car part. So again, and particularly within China, Europe and US, whether it’s do you solar a regular engine, again that’s an entirely different profile. So for investors what we try to stress is think longer term when you’re thinking about precious metals, because it has many uses in our everyday life, but it also performs very differently than one would assume. Gillian: It’s interesting when you mention, you know, the weddings in China and India, when you talk about auto parts it seems like this is also a way to play that demographic trend of the rising middle class in emerging markets. Matt Collins: Exactly, right, yeah. You know, if you look at the correlation of that asset over the long term, you’ll never see it in the short term because there is so much other noise. But in the long term if you play out those trends you tend to see a playback in the gold and silver market. Gillian: Excellent. Now, Larry, I’m going to come back to you. We are talking about the UK and Europe in two separate strokes, even though Brexit doesn’t technically occur until March 2019. But, you know, talk to me a little bit about how you see the UK market functioning differently from Europe. Are there opportunities there right now? Larry Antonatos: We think there are valuation opportunities in the UK, particularly in the real estate market. We spend a lot of time looking at property transactions as a way to assess security prices. You know, very simply, the price of a real estate cash flow on Wall Street through a stock or on Main Street through owning a building, should have some relationship over time. And what we have observed is that as soon as the Brexit vote occurred, you know, roughly 18 months ago, the expectation was property prices would fall. That will happen over time as buildings are bought and sold. But what happened immediately is property stock prices declined, roughly 20%. And our view has been that the UK properties stocks had prior to Brexit been somewhat expensive. Now that they have come down after the Brexit vote we actually think they’re cheap. And that’s one area of our portfolio we are overweight is UK office property. We have looked at property transactions 18 months ago, a year ago today and what we see is that London office property is … the property itself is trading at prices that are consistent with prior to Brexit vote, if not higher. So with the stocks down 20% it’s an attractive entry point. And we have been increasing our portfolio positioning there. Gillian: So perhaps a view that London will still be a commerce hub? Larry Antonatos: You know, it’s not without risk. But we think that there’s a lot of infrastructure in London already. Some of that will definitely move to the continent. And frankly, you know, maybe, you know, a negative for the UK may be a positive for Europe. But we do think that London long term will remain an attractive market from a residential perspective as well as from a business perspective. And we’re comfortable owning securities at a significant discount to real estate value there. Gillian: And, Jim, are you looking at the UK and Europe separately or do you look at them both as an opportunity set together? James Clark: Yeah. Somewhat separately, a lot of it having to do with Brexit and the vote and the uncertainty that goes along with that, especially within infrastructure as it relates to the movement of people and goods. So what we’ve done in the portfolio prior to the vote actually is to not go absent the country because that provides a lot of benchmark risk. But to insulate the portfolio as much as you can in terms of your exposure to those areas that would be most mal-affected should exit have been the vote, which in fact it was. So to reduce the amount of transportation exposure, but to maintain exposure in things like water and electric transmission and distribution where you’re really servicing the population of the country, the country is not going to get up and go away. But so far as the uncertainty around the agreements with the EU and the movement of people and goods you can kind of, you know, back away from that by owning the companies that are serving primarily the population of the UK. Gillian: Perfect. So we’ve gotten a good taste of the opportunity set and what you like right now. So I want to move over to portfolio construction. And we’ve touched on a few of these themes, but let’s dive a little deeper. The first thing I’m going to do is tee up our friend, Jodie Gunzberg at S&P again. She’s going to talk to us a little bit about her views on diversification. Jodie Gunzberg: Commodities have the highest inflation beta or the highest sensitivity throughputs. And they are the same natural resources that are the food and energy inside of CPI. The more energy, the higher the inflation protection, and inflation bonds are also directly linked to the CPI, which makes them also attractive for inflation protection. However, in the last decade, especially for commodities, the returns have been not the best. And mixing the commodities with the other real assets like property and infrastructure, which have had much better returns also still give an inflation protection, but preserve the diversification. Gillian: Matt, would you echo these comments on diversification, what’s ETF security’s take? Matt Collins: Yeah, from our perspective, as we mentioned, people are looking for ways to protect themselves, particularly against inflation. But they tend to go to TIPS. But to Jodie’s point, commodities are sort of the key way of hedging against inflation because by definition the basket of goods is generally speaking within some of these broad commodity indices, like BCOM. But from our perspective if you look at alternative investing, people tend to carve out 5-10% of their portfolio. Unfortunately they sort of treat that as a flyer. I’m going to take a risk on a theme or an individual security. They take too much risk. The point of that segment of the portfolio is to help over the long term with event risk, inflation fits in that, it could be something positive such as population growth and wage growth. But the point of that bucket should be to diversify the other parts of your bucket. So you don’t want to overlook diversifying that segment between assets like real estate that have a sort of longer shelf life in a bull market and precious metals and broad commodities, that can help with varying events. Gillian: So it’s not just about incorporating alternatives as a diversifier, it’s diversifying within alternatives too? Matt Collins: Exactly. Gillian: Larry, how do you think about diversification at Brookfield? Larry Antonatos: So two ways to respond. Within a real asset portfolio we like having multiple real assets because you do get diversification benefits. We love having commodities in the portfolio, bonds behave differently than equities, real estate behaves differently than infrastructure, mortgage backed securities for example are a different type of real estate than commercial property. And the correlation of those asset classes to each other is generally between .5 and .75. So blending them together does improve your sharp ratio. So that’s why we believe that it’s appropriate to have multiple real assets in your real asset allocation. Shifting gears to how a real asset allocation will behave with your traditional stock and bond portfolio, we’ve done a lot of historical analysis looking at the correlation of real assets with stocks and bonds, the volatility, the returns. And what we’ve found is that there’s a pretty consistent pattern historically that adding real assets to your portfolio, listed real assets will improve your efficient frontier, improve your sharp ratio. So for any level of volatility, overall portfolio volatility, the addition of real assets historically has resulted in higher return. Gillian: And as we mentioned it doesn’t really matter what inflationary environment we’re in either, it outperforms either way? Larry Antonatos: I don’t want to be too simplistic that it’s always going to outperform. But I do think that real assets have a very good track record of performing better than equities, maybe not as well as commodities, maybe not as well as natural resource equities, but better than general equities in both inflationary environments and non-inflationary environments. Gillian: Perfect. And, Jim, how do you think about diversification at Nuveen? James Clark: Yeah, similarly if you look at it at the broad portfolio level in the combination of all these things. We go out of our way to kind of mitigate or reduce the amount of commodity price sensitivity in the portfolio because you can go to other providers and you can get that exposure to commodities. So why double you up from your sensitivities by owning something that’s going to give you a higher correlation to what the commodity markets are doing? And then within infrastructure especially when we think about diversification, a lot of it has to do with some of the risks that are more endemic to infrastructure, being regulatory and political. A lot of these are monopolies, you know, sort of natural monopolies in the marketplace where they’re physically located. And as a result of that, policy has a lot to say with what the allowable return is for that particular asset in that company. So we want to have as many assets spread across really as many regulatory jurisdictions and geographic areas as possible to mitigate some of those risks, because you like the risk return characteristics of infrastructure but some of that benefit could be reduced through concentration if you had an event like Brexit as an example. If you’re too concentrated in one place you can have a referendum, you can have a change in policy or politician that can disrupt what should be a little bit more boring return stream. Gillian: So it’s interesting, it’s not just about geographic diversifications, regulatory diversification. When you look at the universe of real assets how are you looking at it for retail versus institutional? Is this a particularly good value add for an institutional portfolio? James Clark: You’re seeing a lot more implementation of listed within infrastructure. You’ve seen real estate be a lot more implemented on the listed side over a long period of time. But I think the nascence of infrastructure as an asset class and especially in North America and to US investors has allowed it now, I think, to kind of lag what traditionally you’ve seen institutional investors in the way that they’ve utilized it. But of late you’re seeing a lot more institutional investors go to the listed marketplace, a lot of it for portfolio sort of allocation reasons, where they can use a listed vehicle to manage the overall allocation that they have within infrastructure. Whereas if they’re a direct investor or they’re a private equity investor you really can’t do that by virtue of the illiquidity of that sort of bucket that they have. And you also see the risk return characteristics march through time and become a little bit more similar to what we have seen in the real estate market. If you look at private real estate returns versus listed real estate returns over the long period of time there’s really not much difference between the two. There is a mismatch in terms of the timing of the return stream, but the overall annualized returns are not that different. And I think the same sort of thing is starting to come to the fore in terms of listed in the infrastructure space versus the private. Gillian: And, Larry, bringing you in here, do you find that there’s a difference in the value add between an institutional portfolio and retail portfolio, are you seeing this pick up in demand? Larry Antonatos: We see real assets having a home in both types of portfolios. Looking historically the first place that institutions and retail individual investors went was to real estate. And real estate I would say, you know, to echo Jim’s comments are a very widely accepted, very mature asset class. Infrastructure is newer and so it’s graining traction, gaining acceptance in both institutional and retail portfolios. If I may I want to elaborate on something that Jim said about diversification of regulation within an infrastructure portfolio. That’s very important, but if you take a step back and just look at how infrastructure works, it works very differently than almost any other business you can invest in. Most asset classes, most businesses are driven by the laws of supply and demand. And where supply and demand intersect, determines pricing. Infrastructure is a great portfolio diversifier because supply is generally constrained; governments may allow only one airport, only one electric utility. So many infrastructure assets, not all of them, but many of them have important supply constraints, almost monopolies. If you think about demand, demand from most businesses is going to move with GDP. We did talk earlier about how transportation infrastructure is GDP sensitive. But the rest of it, energy, water, communications, we will use those things every day whether the economy is good or bad. So there’s little GDP sensitivity. And where supply and demand intersect determine price for many infrastructure assets is irrelevant because the pricing is regulated by the government. So it’s great to have a diversification within your regulation. But what I think is a really important point is that infrastructure and allocation to infrastructure reduces your GDP risk, your business risk and replaces it with regulatory risk. So it’s inherently a great portfolio diversifier. Gillian: So two levels of diversification there. Now, Matt, coming back to you, do you see a difference in the way that retail and institutional use your particular products, whether it’s precious metals or any specific metals? Matt Collins: Yeah. With alternative investing the difference between retail and institutional is huge. You get a premium for taking on liquidity risk. Institutional players can take that liquidity risk by investing directly in infrastructure, and they receive a higher return on their risk, generally speaking. For retail investors or financial advisors they can’t take that risk. They can’t invest in those pools usually. So for them they need to be more careful about the alternative that they’re selecting, meaning liquid alts is a sort of a hot buzzword in the industry. But if you look under the hood it’s just a lot of equity securities. So you need to make sure that what you’re selecting is different than the rest of your portfolio. For precious metals ETFs that’s one of the few categories where you can buy directly and gain a physical asset, a real asset but also have the liquidity profile of an ETF that you can buy and sell. That’s essentially why it acts different than the rest of the market, because it is a real asset. So we just stress to clients to be, one, careful with sort of what they select in the alternative bucket. And just make sure that it’s sort of achieving what they want it to achieve. Gillian: So this actually tees us up nicely. We’ve come to the end of our discussion. So I’d like to give you an opportunity just to summarize some thoughts on where you think that real assets fall into a portfolio and any thoughts you have for an advisor that’s considering making allocations in this space. So, Jim, I’ll start with you. James Clark: Sure. You can look at it a few different ways. Within infrastructure, if I just stay true to that particular discipline, there’s two places that we think it fits appropriately, one would be in the global equity bucket. These are listed global equities, and for that reason you typically have relatively high correlation, not extremely high, typically .7 or .8, so clearly a diversification benefit, but they are listed equities. And so can serve as a nice diversifier within that particular piece of the portfolio. Or if you have a carve out for real assets and you include real estate, infrastructure, commodities, global inflation linked bonds, perfectly appropriate there too. So we would kind of consider those two areas that are the primary ways to implement. Gillian: Excellent. Larry, final thoughts. Larry Antonatos: For retail investors I think it’s important to look at the allocation you have, if you already have real estate, because as we discussed earlier, real estate’s a mature business. If you don’t have any infrastructure, you definitely should look at infrastructure, it provides many of the same investment benefits that real estate provides, inflation protection, income and capital appreciation. But it does it with a slightly lower volatility profile. And it’s a diversifying industry. So I think that would be my main point for advisors is look at the real asset allocation. If you’re just in real estate, think very hard about adding infrastructure to your portfolio. Gillian: Perfect, and Matt, final thoughts. Matt Collins: Yeah. As Jodie mentioned, I would say for investors out there, don’t ignore commodities because they have had such a poor run. We are seeing sort of positive signs in that space. There’s been some structural issues in that space, high cost products, complicated products. So we’re seeing some developments in the way you can access commodities, K1 for ETFs as an example. So we would stress to clients to sort of give that asset class a new look. Don’t just look at it because we are seeing some positive signs and interest from investors. Gillian: Perfect. Well, thank you all so much for taking the time to chat with me here today. I feel like we got a really good picture of the universe of real assets and some of the opportunities you like right now. And thank you for tuning in. From our studios in New York I’m Gillian Kemmerer and this was the Real Assets Masterclass.