Shane Obata is director of investments and portfolio manager with Middlefield Capital Corp.
It has been a great bull market for the majority of investable assets.
Following the global financial crisis, the rising tide of steady economic growth combined with loose monetary policy has lifted all boats. Fixed income has done well, but equities have done even better. While it’s fine to look back and reflect on the good times, it’s more important to look forward.
With yields near all-time lows and markets near all-time highs, investors are rightfully concerned about future growth prospects.
After all, when valuations are elevated, it is reasonable to expect lower future returns. This reality is reflected by institutional investors’ forward return assumptions, which continue to trend lower.
In response to the challenging environment, sophisticated investors have been shifting their allocations away from traditional investments and towards alternatives, such as real assets.
For example, the Canada Pension Plan Investment Board reported a 24-per-cent allocation to real assets for the quarter ending September 30, 2019. This trend was also confirmed by Blackrock’s 2019 Global Institutional Survey, which showed that the majority of institutions intended to increase their exposure.
Real estate and infrastructure are two examples of real assets, which fall into the category due to their physical nature. These assets are often difficult to replicate as a result of scarce usable land, high capital requirements and increasingly complex regulatory frameworks.
Institutional investors typically access real assets through private markets. These assets, specifically in real estate and infrastructure, have generated stronger risk-adjusted returns relative to their public counterparts. In addition, they possess novel characteristics that can help to increase the durability of a broader portfolio.
Private real assets have shown resilience during periods of market turmoil and have exhibited lower volatility, partially because, unlike public securities, most are marked to market on a quarterly basis. This is beneficial during bull markets, since private real assets can trend higher over time while ignoring the constant noise experienced in the public markets. These assets can also help to strengthen portfolios because they have low or negative correlations with traditional equities and fixed income. As a result, investors with exposure to real assets can assume overall portfolio volatility will decrease.
Private assets are traditionally unavailable to retail investors due to onerous due diligence and high minimum investment requirements. Fortunately, there are various opportunities in the public markets.
Within real assets, there are multiple secular growth themes, such as transportation, logistics and data transmission and storage.
Transportation involves industries such as toll roads and airports. These are strategic because they are located close to major population centers, with limited available land. They are also attractive because of their long-lives and highly visible cash flows.
Ferrovial S.A. is one of our favorite investments within this industry. This Spanish-listed infrastructure company has a portfolio of world class assets, including a 44-per-cent stake in the 407 ETR.
This concession has a remaining life of 80 years, which is significantly longer in duration than comparable contracts. The 407 ETR is also extremely profitable because it is fully automated and because Ferrovial applies data science to optimize the rates charged based on different zones, time periods, directions and vehicle types.
All of this results in an EBITDA margin greater than 87 per cent. Ferrovial also has stakes in U.S. concessions in Texas and in Heathrow airport, all of which are highly profitable.
Logistics is another interesting theme that should continue to benefit from the proliferation of online shopping.
Industrial REITs are in high demand because e-commerce sales require three times as much warehouse space as traditional retail. Cold storage facilities are also profiting as grocery delivery penetration rises over time.
One of the best ways to get exposure to the logistics theme is through Granite Real Estate Investment Trust, which we believe is the top industrial REIT in Canada.
The company has been reducing its exposure to Magna International Inc. ever since it was spun-off in 2003. Granite is now firmly focused on warehouses and logistics, which account for more than 50 per cent of revenues. The company has a global footprint, benefits from a low cost of capital and has access to $1-billion of liquidity, which should allow for opportunistic acquisitions going forward.
Lastly, Granite is run by a proven management team lead by Kevan Gorrie, who is known for creating significant value for shareholders as the CEO of Pure Industrial REIT, which was acquired by Blackstone in 2018.
Data transmission and storage is comprised of industries such as network towers and data centers. The former is gaining from the global build out of wireless networks. Carriers need room on these towers because growing data use requires the expansion of network capacity.
Data centers are growing rapidly due to the exponential increase in data generation. This trend creates the need for data centers, which house and maintain computer systems on behalf of clients.
Equinix Inc. is one of our preferred names in this space. The company is a leading data center operator that generates revenues from colocation and interconnection. The former involves charging customers a recurring dollar amount each month in exchange for fixed amounts of space and power capacity within its facilities. Equinix then adds on another fee for extra services such as interconnection, which enables the exchange of private data between businesses.
In our view, the market will continue to reward Equinix for 10-per-cent revenue growth, greater than 90-per-cent recurring revenues and EBITDA margins in the mid-40s.
The aforementioned equities are not cheap, however, we believe their valuations are justified. Ferrovial is supported by exceptionally profitable and ultra-long duration concessions assets while Granite and Equinix are uniquely well positioned to benefit from secular growth in industrial real estate and data infrastructure, respectively.
Real assets are well positioned to benefit from a supportive environment.
We are expecting continued inflows into the space, with 54 per cent of institutional investors showing intentions to increase their allocations in 2019. There is also a necessity for more infrastructure spending, driven by shortfalls in developed markets such as the U.S.
Finally, given that monetary policy is nearing its perceived limits, investors across political allegiances are coming together to support fiscal stimulus, which could serve as the next lever for economic growth.
Yields are near all-time lows and markets are near all-time highs. In response to this challenging environment, investors should consider gaining exposure to real assets.