Given low interest rates across the globe, the hunt for yield has driven many investment managers to increase their exposure to alternative asset classes. In this article, STUART JARVIS focuses on the asset-backed alternative asset classes of real estate, infrastructure and aircraft and maritime finance.
Commonly defined as any investment outside of publicly traded long-only equities and fixed income securities, the alternative investment market has enjoyed a buoyant 2016. The question for investors, large or small, is whether 2017 will continue to match investor optimism.
Real estate
Real estate holds up well when faced with challenged growth and lacklustre returns in more mainstream markets, as witnessed in 2016. The yield spread between property and bonds remains at or above their long-term average, underling the attraction to the sector and with analysts predicting limited risk of values declining.
Traditional headwinds to the real estate sector have not been widespread as follows:
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The oversupply of new build properties relative to the letting market typically leads to lower rents and capital values. However, such oversupply has not been widely apparent in 2016. Part of this is due to restraint on the part of lenders, whose previous excessive lending activity has historically led to higher capital flows as well as softer investment yields. At a macro level, commercial real estate construction and lending activity appears disciplined.
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Economic recessions cause increased unemployment, weaker tenant demand and hence increased vacancy. For the last year however, the major developed markets have seen relatively stable economies and stable to declining unemployment rates. Both have helped support tenant demand.
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Rising interest rates increase the cost of capital in the economy and impact capital values. 2016 was resilient to any rate rises; however, the year ahead may be more challenging. In the meantime, negative interest rates in Europe and Japan may create further capital value upside. The actions of the European Central Bank could broaden to further bolster property markets in France, Germany, Spain and Italy.
Despite the ever-present threat of a weakening in the global macroeconomic environment, real estate should continue to perform well during the near term, supported by sound fundamentals and disciplined investing.
Infrastructure
An abundance of private finance in 2016 meant, and continues to mean into 2017, that investors are turning to infrastructure as an asset class with reliable income streams. 2016 was not without its negative short-term impacts, with factors such as currency devaluation, oil price decline and the slowdown of Chinese economic growth all playing a part. Looking back at 2016, and projecting forward into the year ahead, key themes include the following:
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Mature economies remain the most attractive for long-term infrastructure investment. North America, with its mature, stable economy, major infrastructure backlog and massive investment gap continues to have massive potential for investors.
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Regional demographic changes affect both the amount and type of social infrastructure spending. Ageing populations in the developed markets like Western Europe and Japan require an increasing provision of healthcare facilities. Conversely, countries in Asia Pacific, the Middle East and sub-Saharan Africa increasingly require more schools for their burgeoning youth.
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Growing urbanization and prosperity in emerging markets will require continued large-scale infrastructure finance into water, power and transportation. Alongside these basics are the equally pressing investments required into consumer-led sectors that provide and distribute the raw and finished materials for consumer goods.
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Emerging markets will need to develop far more effective business environments for investors. Unpredictable regulatory regimes, bureaucratic delays and fungible land rights all combine to stifle much-needed infrastructure investment.
Aircraft and maritime markets
The aircraft and maritime markets have been affected by the same global macro factors, albeit with differing outcomes as follows:
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Shifts in global demographics and population growth rates, coupled with long-term economic growth in developing markets, have had marked implications for the maritime and aviation sectors. The middle class is growing in the emerging economies of Asia, Africa and Latin America where disposable incomes are driving growth in demand for both outward travel and inward flow of commodities and finished goods.
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A strong dollar and low oil prices have had a favorable impact on the aviation market and boosted profits. Industry margins remain near all-time highs, with cost controls now paying dividends. The shipping industry similarly benefits, with the demand for oil tankers having picked up and the operating costs of ships having gone down due to the lower oil prices.
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Fueled by low interest rates and stretched loan tenors, the container shipping industry especially is, however, reported to be over-leveraged at a low point in the cycle. Industry debt levels have risen sharply, with commentators concerned that many carriers could come under severe stress and remain vulnerable when global interest rates normalize.
Conclusion
The two overriding trends affecting the alternative asset classes investment market in 2016 and into 2017 are the effects of a low interest rate environment and cheaper oil prices. Both are fueling a flight to alternative asset class investment yields and fueling, more broadly, an economic resurgence. Neither will necessarily remain low and accurately calling when their eventual rise will start is the challenge for 2017.
Stuart Jarvis is the investment director at Amiri Capital. He can be contacted at [email protected].