Toronto, Canada - November 16, 2016: Old and new buildings in Toronto downtown
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With inflation running higher for longer and the threat of a recession lingering as monetary policy tightens, many investors are looking to protect their portfolios.

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Real assets offer attractive defensive characteristics that could contribute to this recession proofing, says Larry Antonatos, managing director and portfolio manager with Brookfield Asset Management.

“Relative to many other businesses, many infrastructure businesses and real estate businesses offer more predictable revenues and predictable cash flows,” Antonatos said in an interview earlier this month. 

For example, for real estate, predictable revenues are a result of long-term leases; in infrastructure, revenues are driven by regulated pricing and limited competition.

However, the performance of real assets will reflect different sensitivities to growth and inflation, given different business models.

“Real estate is generally a free-market business driven by the traditional interplay of supply, demand and pricing,” Antonatos said. “In contrast, infrastructure is generally a regulated business where government involvement can play a role in the drivers of supply, demand and pricing.”

As a result, infrastructure can be more defensive than real estate, he said.

For example, the real estate rental rate can be volatile as it’s determined by free-market negotiations and therefore impacted by supply and demand dynamics. Conversely, infrastructure provides essential services, so demand is generally steady, and supply growth can be limited by government regulation.

In a modestly slowing economic growth environment, both real estate and infrastructure should deliver moderate returns and outperform traditional cyclical businesses, Antonatos said. “This is due to the defensive benefit of predictable revenues and cash flows from both real estate and infrastructure.” 

In a true recessionary environment, infrastructure, which has less sensitivity to economic growth, should outperform real estate as well as traditional cyclical businesses. 

That said, sub-sectors in both real estate and infrastructure range in their sensitivities to economic growth, creating “more granular investment opportunities,” Antonatos said. 

Within real estate, growth sensitivity is higher for property types with shorter lease durations, such as hotels, self-storage and residential. Instead, Antonatos said to look for property types with longer lease durations, such as industrial and office.

Within infrastructure, growth sensitivity remains high in the transport sectors — namely airports, seaports and toll roads — because of their sensitivity to volume. Conversely, utilities and communications tend to have steady demand and are therefore more attractive investments in a recessionary environment. 

“Within both real estate and infrastructure, there are property types and sub-sectors that are attractive in any market environment — cyclical growth environments as well as recessionary environments,” Antonatos said.

Looking forward, he outlined three scenarios that could occur over the next year. 

First, there’s a high probability of slowing growth but no recession. In this environment, infrastructure and real estate should both perform well, and well relative to traditional businesses, he said.

Next, there’s a moderate probability of a short but shallow recession. Again, infrastructure and real estate are attractive investments that should perform well, and well relative to traditional asset classes, he said.

Lastly, there’s a low probability of “a deep and prolonged recession,” he said, if central banks make a policy error. In this scenario, infrastructure should still perform well, but real estate may be impacted.

With the highest probability being slow growth with no recession, Antonatos said he remains confident in the performance of both real estate and infrastructure over the next 12 months.

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