The three common asset classes in the real assets space are infrastructure equity, real estate equity and real asset debt, says Larry Antonatos, managing director and portfolio manager with Brookfield Asset Management’s Public Securities Group in Chicago.

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They present a few long-term opportunities, he says, including: income from dividends on equity and coupons on debt; capital appreciation from the underlying appreciation of the real assets; and inflation protection from inflation-linked pricing on underlying assets, such as regulated infrastructure assets.

While debt investments tend to emphasize income, equity investments tend to focus on capital appreciation and inflation protection. Antonatos, whose firm manages the Renaissance Real Assets Private Pool, says this is how the investments are used in that portfolio.

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The long-term risks of these assets vary, leading to portfolio diversification, he adds.

Risk profile of infrastructure equity

The risk profile of infrastructure equity is “significantly different” from many other equity asset classes, says Antonatos. That’s due, in part, to the “differentiated supply, demand and pricing of the infrastructure business model.”

For example, “the supply of [these] assets is generally constrained since many infrastructure assets are monopolies or semi-monopolies.” A company could be the only electrical utility serving a town, Antonatos points out.

At the same time, competitive risk for infrastructure “may also be lower than for other businesses,” even while “the demand for […such] services is generally steady. Many infrastructure assets provide essential services with little sensitivity to GDP.”

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Consider that people use electricity every day, says Antonatos. It’s considered an essential need “whether the economy is strong or weak.” As a result, “economic cycle risk for infrastructure […] may be lower because of the steady demand.”

Regulation is tight around the pricing of infrastructure services, particularly in the case of “the more monopolistic infrastructure assets,” he says. “Accordingly, regulatory risk may be higher.”

Real estate equity versus debt

Real estate equity offers a risk profile that’s similar to many others. In contrast to infrastructure, real estate is “a free market business governed by the fundamental laws of supply, demand and pricing,” says Antonatos.

“The supply of real estate space is generally unconstrained, and cycles of excess supply have been historical drivers of weak investment performance,” he explains. Meanwhile, “the demand for real estate space is generally cyclical, moving with GDP, [and] cycles of demand growth have been historical drivers of strong investment performance.”

When looking at the pricing of real estate, Antonatos suggests studying the intersection of supply and demand: “When supply is modest and demand is strong, landlords may have more pricing power,” he says.

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For its part, real asset debt—which includes the debt of infrastructure, real estate and natural resources companies—can offer “a risk profile that’s attractive relative to broad market debt,” says Antonatos. That’s due to its “slightly lower historical default ratio and slightly higher historical recovery ratio.”

Portfolio positioning going into 2018

Heading into this year, the Renaissance Real Assets Private Pool was overweight infrastructure and real estate equity, says Antonatos, “based on attractive valuations.” Conversely, it was underweight real asset debt, “based on tight credit spreads.”

Within infrastructure equity, the portfolio was—by sector—overweight energy and underweight utilities. In the latter, “valuations were largely unattractive and historical interest rate sensitivity had been high.”

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Within infrastructure equity, the portfolio was overweight Europe due to improving economic growth, and underweight Asia-Pacific, says Antonatos.

In real estate equity, U.S. regional malls were the top pick. In that space, says Antonatos, “valuations appeared to be attractive, even considering negative sentiment on bricks-and-mortar retail.”

On the other end of the spectrum, the portfolio was underweight U.S. healthcare real estate due to issues with “increasing supply, and the uncertainty of healthcare policy reform,” he adds.

Within real estate equity, the portfolio was overweight the U.K. and underweight the U.S., “where fundamentals appeared to be slowing,” says Antonatos.

The portfolio’s real asset debt exposure was organized by credit quality. The portfolio was “underweight investment-grade, where spreads appeared to be tight, and overweight high yield, where credit quality has continued to improve,” he says. Energy infrastructure debt was appealing, while he and his team were more cautious on natural resources debt.

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