Chalk drawing of house

The low interest rate environment since the start of the pandemic has supported global economic activity but also boosted broad equities markets, with other asset classes not keeping pace.

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That’s left some real assets attractively valued compared to equities, said Larry Antonatos, managing director and portfolio manager at Brookfield Asset Management.

While broad public equities are approximately 30% above pre-Covid highs, as measured by the MSCI World Index, benchmarks for public real estate and infrastructure equities have returned only about 5% over the same period.

“Because of this 25% return differential, public real estate and infrastructure appear very attractively valued relative to broad equities,” said Antonatos. “This is an important investment opportunity.”

However, in order to consider investment opportunities in a future interest rate environment, Antonatos said advisors must first consider three important drivers of interest rates: central bank policy, economic growth and inflation. 

The performance of real assets will reflect different sensitivities to growth and inflation.

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

Because of these different business models, real estate is generally more sensitive to economic growth and infrastructure is more sensitive to inflation. According to Antonatos, if growth rises more than inflation, real estate should outperform infrastructure. On the other hand, if inflation rises more than growth, infrastructure should outperform real estate.

Antonatos uses a four-quadrant map of economic growth versus inflation. Within the quadrants, he expects real estate and infrastructure to perform as follows:

  • Rising growth and rising inflation: Both real estate and infrastructure should deliver strong returns but may fail to keep pace with more cyclical sectors.
  • Rising growth but falling inflation: Both real estate and infrastructure should deliver strong returns, with real estate outperforming infrastructure.
  • Falling growth but rising inflation: Both real estate and infrastructure should deliver moderate returns and should outperform more cyclical sectors due to the stability of cash flows and the benefit of inflation escalators. Infrastructure should outperform real estate.
  • Falling growth and falling inflation: Both real estate and infrastructure should deliver moderate returns and should outperform broad markets due to the defensive benefits of long-duration cash flows.

The “sweet spot” within these four quadrants, Antonatos said, is an environment with moderate growth and inflation where real estate and infrastructure deliver strong returns that aren’t outpaced by more cyclical sectors. He predicts this macroeconomic environment to occur over the next few years. 

In addition, the portfolio manager noted that both real estate and infrastructure have sub-sectors with a range of sensitivities to economic growth and inflation. 

For example, within real estate, growth sensitivity is higher for property types with short lease durations, such as hotels, self storage and residential apartments. With regards to infrastructure, sensitivity is higher for sectors where pricing is contractually tied to inflation, such as certain utilities and transportation.

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