Real asset study

In search of resilience in an uncertain world

Foreword by Euan Munro

Much has changed since we published our 2018 Alternative Income Study. At that time, the global economy was running along nicely, which was expected to bring an end to a decade of monetary easing by central banks; most major equity indices were surging; and talk of trade wars was dismissed as rhetoric rather than a major risk.

Fast forward to today, and a sense of unease has returned to financial markets. Growth is slowing; central banks, led by the US Federal Reserve, have done a U-turn on interest-rate hikes; the stack of negative-yielding bonds had reached $17 trillion in September, reflecting investor concerns; equities are down; and the prospect of trade wars has evolved into a key risk for the global economy.

Despite, or perhaps because of this, the growth in demand for real assets among institutional investors remains strong. This drove our decision in May 2018 to combine our Real Estate and Alternative Income teams into Aviva Investors Real Assets, and is why we have broadened the focus of our survey this year to cover all the key asset classes in the sector. We have also expanded the reach of our survey to 500 senior investment professionals at insurance companies and pension funds across Europe.

Given the political and economic backdrop, the continued appetite for real assets is perhaps unsurprising. The diversification and cashflow-matching characteristics such assets can offer against publicly-traded securities are well known. And, with bond yields likely to remain compressed, it is understandable that investors look to real assets for positive returns, or what is commonly referred to as illiquidity premia. Meanwhile, as European governments contemplate whether to turn on the fiscal taps to stave off recessionary pressures, state allocations to infrastructure in conjunction with private capital could provide another tailwind.

Another undeniable trend is the growing influence of environmental, social and governance (ESG) factors. Institutional investors, and the asset managers they partner with, need to demonstrate their allocations have a broader benefit than returns alone. There is an argument that integrating ESG into portfolios is more straightforward in the real asset world than it is for public assets like bonds and equities. As ultimate asset owners, investors are not far removed from other key stakeholders, and should therefore be able to exert more influence over decision-making.

These trends are all positive for real assets, but the sector is not without its challenges. With new entrants coming to the party and existing investors increasing their allocations, there is a risk of overcrowding in parts of the market, while liquidity remains a concern for some.

As ever, investors need to carefully consider all the opportunities and risks when determining their investment strategies. It promises to be another fascinating year for real assets.

This research was conducted online from 30th April – 10th May 2019 by FTI Consulting’s Strategy & Research team. For the purposes of this analysis, we have grouped the following geographies across Europe as below.

Allocation change

76% expect to maintain or increase their allocations to real assets in the next 12 months

Cashflow matching

84% consider cashflow matching an integral driver when investing in real assets

Cashflow matching

84% consider cashflow matching an integral driver when investing in real assets

Western Europe

United Kingdom, France, Germany, Republic of Ireland and the Netherlands

Southern Europe

Italy and Spain

The Nordics

Denmark, Finland, Norway and Sweden

Despite global turbulence, investors continue to grow their allocations to real assets, even as they face challenges such as trade wars and the need to address ESG issues.

The flip side to growing demand is one of the major barriers to real asset investment: a lack of supply. Some investors are becoming wary of overpaying for a small pool of assets for which their contemporaries compete, but in which few will invest. This has led some to consider alternative routes of access – through pooling of assets with other investors to get access to larger projects (co-investment), or by exploring a more diverse range of assets to invest in.

As one investor told us: “Speed of deployment in the real assets arena can be challenging generally – and even more so in uncertain times. If there is a limited number of good quality assets, not everyone will be able to deploy as quickly as they think. Deployment and lack of supply overall is a risk.

“Assets with smaller pools – like equity-release mortgages – might trade more frequently than big-ticket portfolios of loans. A lot of people in my industry are thinking about investing in the same things, and if you go back to the last boom it can create a situation where investors have taken on a level of risk that, in 2-3 years’ time, will turn out to be egregious.”

While sovereign wealth funds led the way in real assets investment at the beginning of the decade, pension funds and insurance companies have become active investors in this area in recent years. At the same time, new types of projects demand greater emphasis on risk management and transparency.

The political arena is also driving interest in real assets, with both the Trump administration in the United States and the Boris Johnson-led government in the United Kingdom pledging large-scale infrastructure investment on the back of historically low interest rates.

The definition of a real asset investment is also evolving and expanding as innovation continues. Promises of improved digital infrastructure are not only likely to prove a vote winner, but are also set to provide secure new income streams for investors. These include 5G infrastructure, data centres, and charging points for electric vehicles.

Transport infrastructure continues to be fertile territory, with electric vehicles in the vanguard. Darryl Murphy, Head of Infrastructure Debt at Aviva Investors, says: “The growth of electric vehicles has taken place much faster than expected and could have a significant influence on infrastructure over the next ten years.”

Real estate is also complex, fast-changing and affected by political and societal changes. With retail property – particularly in the United States and Britain – impacted by a structural shift towards e-commerce, safe havens such as real estate debt secured against non-retail real estate are growing in their appeal.

According to Cass Business School figures, the outstanding UK loan book value of £164.5bn at year-end 2017 was allocated as follows: £124.5bn held by banks & building societies (75.5 per cent), £23.9bn (14.5 per cent) by insurance companies and £16.1bn (9.8 per cent) by other non-bank lenders. This compares with banks providing 98 per cent of UK lending in 2007.

Interest rates are a cause for concern. However, it is unclear whether this reflects a longer-term fear they will rise, or the shorter-term uncertainty associated with a recessionary or deflationary environment.

Lower interest rates may extend the real estate cycle, as yields continue to be above the bond market’s, but the counterargument is that occupational risk in some territories is rising. Yet in mainland Europe, demand remains robust in office and logistics real estate.

With real estate generally judged to be in the late stages of its current cycle, there is growing interest in ’alternative’ asset classes such as build-to-rent residential or medical property.

Overall, real assets look set to continue to grow, albeit grappling with the same global issues other asset classes face in 2019.

Which of the following real assets do you expect to increase investments in over the next 12 months?

Over half of insurance experts expect to increase investments in real estate debt (54 per cent), infrastructure equity (52 per cent) and structured finance (51 per cent) in the next 12 months. Pension funds expect to increase investments in direct real estate (53 per cent), infrastructure equity (53 per cent) and structured finance (52 per cent).

Which of the following do you believe to be very challenging when investing in real assets in Europe over the next 12 months?

The ‘impact of regulations on real asset investment’ and ‘pressures of liquidity vs illiquidity’ (both 44 per cent) are deemed most challenging for pension funds.
Both insurance (37 per cent) and pension funds (30 per cent) feel a ‘lack of regulatory harmony across Europe’ is very challenging to investment (rising to 54 per cent for insurance in Southern Europe); while a similar percentage cite the pressure of understanding ‘evolving consumer patterns’ (insurance: 36 per cent; pension funds: 38 per cent).

What types of assets will Aviva Investors Real Assets be investing in over the coming years?

We have spent a lot of time thinking about our real assets investment philosophy and where to invest across Europe. We’ve identified 11 cities in Europe and five UK clusters that we think offer the best growth opportunities for investment.

For us, it is about creating places where people want to live, work, play and learn. These are large-scale developments with a mix of retail, office and residential. We have some exciting projects underway in Paris and London, in particular.

We really like the alternatives sector in the UK. Care homes and purpose-built student accommodation are the two standout use cases we’ve been investing in recent months. Both have great covenant strength and offer stable long-term cash flows. Over time we expect that model to be replicated across Europe, underpinned by structural societal shifts.

How will you tackle the shortage of supply of investment opportunities?

We have 320 people across our pan-European platform and over 100 of those are dedicated to the sourcing and acquisition of real assets across Europe.

Our large off-market capability means we see assets much earlier and can work on the structuring and even get involved in the design.

What impact would a rise or fall in interest rates have on the real assets world?

We see low interest rates continuing in the medium term, and that is great for real asset pricing. The risk would be a sharp increase in interest rates, which would affect borrowing costs and could cause real estate and infrastructure projects to fall in value. A longer term, more gradual rise in interest rates is fine; investors cope with that very well.

What global capitalflows do you foresee in the near term?

A lot of global investors are looking to invest into UK commercial property, but are waiting to push the button on investment due to uncertainty around Brexit. Today, the global flows are toward continental Europe. And because we have a large real estate business in Europe, we can act as a conduit for those global flows into European cities we like. The demand for real assets remains strong from global players.

Why was Aviva Investors Real Assets created?

The boundary between the different asset classes in the private market has been blurring. At the same time, investors are looking to increase their allocation to real assets by 50 per cent by 2025, a huge transition.

Investors are looking across the spectrum and increasingly want multi-asset portfolios, with an outcome-oriented focus. Clients typically want growth, or long income, or a private debt portfolio. What we are able to do is mix together infrastructure, real estate and private debt to provide those three outcomes.

Clients are also able to co-invest, both with each other and alongside Aviva. The real assets platform gives us even greater scale, which enables us to execute some of the larger deals in the market. Early access and being involved in the structuring means better covenants, better yield opportunities, and fast deployment of capital on behalf of our clients.