Central banks have responded to the Covid-19 pandemic by lowering rates, with the Bank of Canada’s target rate now at 0.75% and the Federal Reserve’s effectively at zero.
For some real assets, a low-rate environment is a boon, says Larry Antonatos, managing director and portfolio manager at Brookfield Asset Management’s Public Securities Group in Chicago.
“In falling rate, risk-off environments like this … real estate and infrastructure have historically outperformed traditional equities due to the defensive characteristics,” Antonatos said in a March 5 interview.
Real estate cash flows are based on contractual leases, typically five to 10 years in duration. Infrastructure cash flows are backed by “attractive supply and demand pricing fundamentals,” said Antonatos, who manages the Renaissance Real Assets Private Pool. Supply is usually constrained since many infrastructure assets, such as electric or water utilities, are monopolies.
“Demand for infrastructure services is generally steady whether the economy is good or bad because infrastructure provides essential services,” he said.
“For example, electricity, water, or cellphone communication. And the pricing of infrastructure services is generally governed by regulation, or by long-term contracts, with increases in pricing frequently tied to inflation.”
Still, there are certain pockets that outperform others, he said. “Sectors with less economic sensitivity tend to outperform sectors with more economic sensitivity.”
Within real estate, buildings that have tenants with longer leases tend to outperform, Antonatos said: offices with 10-year leases compared to hotels with one-night leases, for example.
Within infrastructure, monopolistic utilities, like electricity and water, “tend to outperform the GDP-sensitive transportation sectors, such as airports, seaports and toll roads,” he said.
What if rates rise?
While low rates might be here to stay, Antonatos also outlined how upward movements in rates impact real assets.
“What we see in a rising interest-rate environment is improving economic fundamentals, so the potential to grow your cash flow faster,” he said.
“To some extent, that is offset by the rising interest rate, which creates a headwind to valuation by increasing the discount rate. What we really look for here is, if the tailwind from improving economic growth is greater than the headwind from rising discount rates, real assets can perform well in rising-rate environments.”
Overall, Antonatos noted “modest increases in interest rates are good for real assets,” while dramatic increases could lead to underperformance compared to broad equities.
“In that kind of environment, other equities may have the potential to grow their cash flows faster,” he said.
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