The prospect of rising interest rates in the U.S., both for the short- and long-term, is a growing concern for real asset investors.
So says Larry Antonatos, managing director and portfolio manager with the Public Securities Group at Brookfield Asset Management in Chicago. During a late March interview, he spoke about the historical impact of tightening cycles and the potential future impact of today’s rate-hike cycle on real asset investments.
On March 21, the U.S. Federal Reserve raised the target range for its key rate by a quarter-point. The range went from 1.25% to 1.5%, to 1.5% to 1.75%—the central bank’s sixth increase since 2015. That was followed by new Fed Chair Jerome Powell stating in his first speech, on April 6, that he’s committed to gradual rate hikes.
Meanwhile, U.S. inflation data in February suggests inflation pressures remain muted—for now. The consumer price index inched up 0.2% for that month, after jumping 0.5% in January, the Labor Department said on March 13.
Antonatos, whose firm manages the Renaissance Real Assets Private Pool, offered his assessment of how short-term and long-term interest rates are affecting the real asset space.
Real asset debt beating real asset equities
Throughout the Fed’s current tightening cycle, which began in November 2015 with a starting rate of 0.25%, real asset equities in the U.S. have not performed as well as in previous rate-hike cycles.
As of late March, “Infrastructure equity and real estate equity had delivered 0.8 times and 0.6 times, respectively, the return of global equity,” says Antonatos. But real asset debt was doing better, given it was “delivering roughly two times the return of global bonds.”
“We have a few more years to go […] so it remains to be seen what will happen over the whole cycle,” he says. “Market expectations are for an ending rate of 3% at the end of 2020,” and that “implies a total of 270 basis points of tightening over 61 months.”
The Fed’s previous tightening cycle began in May 2004 at 1% and ended in August 2007 at 5.25%—that represented a total of 425 basis points over 39 months, says Antonatos, so it was much more aggressive.
“Over that cycle, infrastructure equity and real estate equity delivered roughly two times the return of global equity, and real asset debt delivered roughly 1.5 times the return of global bonds,” he adds.
What about long-term rates?
The impact of long-term interest rates, which are driven by the market and not U.S. federal policy, can be measured by looking at the historical performance of real assets using standard statistical models, says Antonatos.
Based on his firm’s analysis, “We have assumed a 100-basis-point shock to the U.S. 10-year Treasury yield,” he says. They predict infrastructure will have a flat performance over that time.
Real estate equity will underperform versus global equity, he adds, with the former bringing in -2% and the latter 5%. Antonatos says broader equities will primarily benefit from “strength in the financial sector.”
On the upside, real asset debt will likely offer performance of roughly -4.5%, “which is significantly better than the expected performance of global bonds, [at] -7%.”
Despite the pressure of rate hikes, Antonatos says the long-term opportunities of real assets remain, including “income from dividends on equity and coupons on debt, capital appreciation from long-term appreciation of underlying real assets, and inflation protection—from the inflation-linked pricing on underlying real assets such as regulated assets.”
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