The perils of chasing niche infrastructure

Frithjof van Zyp
— 1 minute read

Within real estate and infrastructure investing, what was niche is now becoming mainstream, writes bfinance Australia's Frithjof van Zyp.

Around the world, infrastructure funds are increasingly tapping into sectors that would previously not have been included in their portfolios, such as energy storage, data centres and timberland.

Bfinance, which advises more than 300 of the world’s most sophisticated investing institutions in over 30 countries, has seen increased demand from institutions globally for these and other niche assets such as renewable energy infrastructure and real estate debt over the last three years.

The trend towards niche assets continues apace in 2018, as investors seek diversification and higher returns in the late stage of the market cycle, where returns from core real estate and infrastructure assets have become compressed.

Australia’s institutional investors have been at the forefront of the changes. The size of Australia’s investment management industry, underpinned by compulsory superannuation contributions, makes it a significant player globally, with the country’s superannuation funds alone holding more than $207 billion in infrastructure and property assets .

Australia’s biggest institutional investors have been early to diversify their own holdings of so-called “real assets” to incorporate more than just traditional commercial property and infrastructure – investing in asset classes such as timberland and renewable assets.

Australian institutional investors were among the first to develop real asset units, bringing a diversified range of real assets under one division instead of splitting them into the traditional classes of infrastructure and real estate.

At the heart of the changes is a mindset that is less focused on labels and prioritises core characteristics, such as inflation sensitivity, diversification from equity, and yield.

However, there is a need for caution. Recent research has demonstrated that diversified real asset portfolios have outperformed standalone infrastructure, real estate or agriculture portfolios at times of low market returns, but only if done right.

Beware of one-size fits all solutions

Customisation is critical when it comes to real assets.

Over the past year, bfinance has worked with a variety of pension funds, foundations and other clients on implementing real asset investments, either broadly or within particular sectors.

In general, where institutions are relatively new to the asset class, we have advised starting with more traditional property and infrastructure, but with an eye to building potential exposure to other sectors over the long term.

For institutions that are highly advanced in their approaches due to a long experience with different genres of real asset investment, including some Australian and Canadian clients, the main priority has been building complementary niche exposures around the traditional strategies, such as water titles and royalties.

Intense scrutiny also needs to be applied to the new products and services on offer from asset managers.

Seeking to take advantage of the industry trend toward niche real assets globally, many asset management firms have developed real asset divisions over the past few years and the trend continues in 2018.

Given the organisational overhauls involved when managers have built, bought or branded these teams, investors should pay close attention to issues such as staff turnover, integration and leadership when evaluating and selecting managers.

New products need scrutiny

The newest development is the rise of multi-real-asset investment strategies. Asset managers are launching strategies or structuring wrappers that offer breadth across multiple sectors.

Structures range from “funds of in-house funds” to true diversified pooled funds, and some of these niches were very esoteric indeed: the likes of pharmaceutical intellectual property and music catalogue royalties stretched “real asset” definitions to the limit.

Each of the three main structures available—pooled funds, fund of funds, and fund of in-house funds—needs careful evaluation.

For instance, alignment of interest should be watched with care when it comes to fund of in-house funds: it is not always clear that clients’ assets are being invested in the sub-funds in a manner that best suits their interests as opposed to the manager’s fundraising timeline.

Fund-of in-house funds may have an edge when it comes to customisation, however. Their ability to piece together chunks of sub-funds can match well with the varying nature of investors’ demands.

As far as costs go, funds of external funds tend to be the most expensive, due to the double layer of fees.

With a trend of this magnitude sweeping the industry, the fallout can be complex and challenging.

Diversified real asset portfolios can theoretically outperform in this late stage of the investment cycle; however, investors should take great care.

Supposed real asset investments do not necessarily deliver the desirable characteristics associated with this space. Implementation is the critical challenge.
At the end of the day, ‘real assets’ is only a label: what’s inside the tin is what matters.

Frithjof van Zyp is the Australian director of bfinance.


The perils of chasing niche infrastructure
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