The Great Lockdown recession brought on by the coronavirus pandemic is unique in many ways.
While the global gross domestic product is expected to shrink sharply by -4.5 per cent in 2020, the demand destruction is not ubiquitous. In fact, demand for groceries, logistics and data has been unprecedented, allowing “stay-at-home” providers to report solid growth.
In March, the global stock market entered into a bear market with volatility not seen since the global financial crisis (the VIX Index spiked to more than 80). Although the global equity market has snapped back sharply from its March lows, investors nevertheless question the virility of the rebound given the global coronavirus pandemic.
In such an environment, what is an investor to do? Institutional investors have been increasing their allocations to real assets, over and above their allocations to real estate. A general misconception about real assets is that it involves investing in physical commodities like Brent crude oil, which returned -69.5 per cent in March (and Tapis crude oil returned -55.5 per cent) as Saudi Arabia and Russia disagreed on production cuts.
In today’s economy, data are more real than oil. Last year PGIM’s Institutional Advisory & Solutions published The Diversity of Real Assets which analysed how the macro-economic and market sensitivities of real assets differ, not only at the asset class level but also at the sector level. These differences make it all the more necessary for investors to carefully align their choice of real assets and sectors with their investment objectives.
To illustrate the diversity of real assets consider many of the goods and services that have been in high demand during the pandemic – the rush for orange juice to build viral immunity, toilet paper for hygiene, home deliveries for supplies while in lockdown, internet to study and work, and gold coins for wealth preservation. They all have a common theme: real assets.
Farmland – We showed in our paper that farmland historically has negative sensitivity to economic growth and surprise (i.e., countercyclical). Farmland REITs returned an average of 0.5 per cent in March. In grains, due to higher export demand and lower wheat surplus from drought, Western Australia (WA) wheat futures returned 19.0 per cent. In contrast, in softs, with worldwide retail store and factory shutdowns cotton futures returned -12.5 per cent, as prices hit 10-year lows.
A combination of drought and frost conditions led to lower production in oranges. Countries like the US which are significantly impacted by coronavirus saw an increased demand for orange juice, and orange juice futures returned 24.1 per cent.
Timberland – Generally, timberland is a growth asset. In March, global timber and forestry equities returned -11.6 per cent. However, our Diversity paper discussed how during the global financial crisis the demand for pulpwood didn’t falter, unlike for sawn wood with its ties to the housing market. Even now, a high demand for toilet paper and packaging also means continued demand for pulpwood timber, providing price support in Q1 2020.
Real Estate – While the brick-and-mortar-heavy retail global REIT sector was hit hard (-35.6 per cent), the global industrial sector (-2.2 per cent) and warehouses fared relatively well. Shifting consumer buying patterns increased warehousing demand, which also led to a hiring surge for warehouse and delivery workers. Similarly, an increase in internet traffic as a result of work/study from home has led to increased demand for data centers (specialty sector returned 3.2 per cent).
Infrastructure – While listed global infrastructure had a similar sell-off as equities (-15.3 per cent; hedged returns), not all sectors performed as poorly. With increased internet traffic we also saw increased capital expenditure from telecommunication companies. The communication infrastructure sector fared relatively well, returning -4.2 per cent. Water and electricity distribution infrastructure also held up better and returned about -7 per cent. Due to consumer and industrial demand destruction, brownfield sectors which are often perceived as safer assets fared poorly (airports -33.2 per cent and ports -25.6 per cent).
Gold – Gold has a role to play in both stagflation and stagnation environments. We saw in March that while gold’s daily correlation to equity returns may have been positive (i.e. both gold and equity had sell-offs on the same day), gold returned 7.0 per cent overall for the month.
Such wide dispersion in real assets and sectors suggests having a diversified portfolio exposure, and perhaps also having a portfolio that is actively managed.
A Stagnation Protection real asset strategy portfolio is expected to perform in low growth and low inflation economic environment as it combines some of the defensive assets and sectors discussed above.
Harsh Parikh, principal, PGIM Investment Advisory & Solutions
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