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REAL ASSETS - Appeal for long-term sources of diversification

THE ESSENTIAL

In a world of low interest rates, a benign growth outlook and crowded trades in some areas of traditional markets, investors will continue to look for portfolio diversification and yield enhancement.

In our view, selectively allocating to real assets can help to capture the liquidity premiums in the market, as well as to potentially enhance income returns and protect against inflation given the recurrent cash flow associated with some investments such as infrastructure and real estate.

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November 2018

Novembre 2018

The Article

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The drivers for real assets in 2019 are set to remain broadly unchanged from last year. In a low yield environment, especially in Europe where the ECB is unlikely to raise rates before Q3 2019, investors are structurally more inclined to invest in alternative asset classes that, thanks to their ability to capture illiquidity premium, can potentially deliver higher income and returns while diversifying risks. As a result, fundraising in private markets and real assets, which have just recovered to their pre-crisis levels, could even accelerate. On fixed income, investors still look favourably at private debt and credit continuum solutions (which combine liquid and illiquid instruments), given the benefits they may provide to portfolios both in terms of diversification (out of the most crowded areas of the traditional credit market) and potential yield enhancement. Therefore, we are expecting an acceleration in demand for this asset class over the next year. Beyond market conditions, prudential regulation in the financial sector could also continue to boost demand for alternative sources of financing to complement banks’ intermediation in financing the real economy.

In a late cycle phase, a lower return and riskier investment environment will require investors to reassess their asset allocation, increase diversification and consider real assets to capture liquidity premium. Selection will become increasingly relevant to capturing the opportunities that a more challenging environment can open up to long-term investors.

Real assets investments, in particular infrastructure and real estate, potentially act as a structural hedge against inflation, an important feature for investors since the risk of higher inflation remains on the radar. On infrastructure investing, we believe that the current outlook will be sustained due to the focus from policymakers in further supporting the recovery beyond this cyclical phase. The current economic recovery in Europe could also favour real estate due to the demand for space and the expected increases in rent (expected to be the main driver of performance), as anticipated in France, Spain, Germany and Benelux. In our view, active management strategies in real estate will be critical to dealing with present high valuations and trying to protect against the future risk of rising interest rates.

On private equity, the outlook is more challenging. A complex macro environment requires investors to be even more selective in terms of geographic areas and appropriate target companies. We think Europe still offers a positive economic backdrop and we expect private equity to remain in demand in this geographic area. However, it will be vital to identify those factors that make a company well equipped to create value for investors over the long term. Among them, we highlight the following: the quality of the management team and its involvement in the capital structure; having solid fundamentals and a history of profitability; the ability to gain a competitive advantage by having consistent organic growth and a strong desire to seek external growth though internationalisation; and a flexible approach and the agility to adapt rapidly to changing environment conditions. Yet private equity remains one of the best performing asset classes over the long run. For investors with a sufficient time horizon (8-10 years), we think that private equity remains a valuable source of returns and illiquidity premium. Based on all market and structural conditions considered above, we believe that in the long run, real assets will likely continue to be in strong demand. Recent Preqin’s projections estimate that alternative assets under management will hit $14.0 trillion by 2023, up by 59% from $8.8 trillion as of the end of 2017. Among the rising trends in alternative investing, there is also the higher focus on ESG considerations as a key element to identifying best business practices.

Amundi Research & Investment Insights Unit
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REAL ASSETS - Appeal for long-term sources of diversification
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