Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Instos search for inflation protection in real assets
Nearly two-thirds of institutional investors plan on increasing their allocation to real assets in the next two years, according to Aviva Investors’ latest Real Assets Survey. The finding is more “evolution than revolution” as 47 per cent of respondents reported existing real asset allocations of up to ten per cent – though nearly the same number are planning on doubling that.
But the advent of a new inflationary regime is the main driver of interest in the asset class, with 53 per cent of respondents saying they plan on allocating to real assets for inflation-protected income – up from just one third three years ago. Around 42 per cent of APAC institutions cited inflation-linked income as the main influence on their real assets allocations – up from 27 per cent – while one third of institutions named capital protection as their main reason for using real assets. Long-term income generation as a driver has dipped from 42 per cent in 2019 to 38 per cent today.
“After years of benign macro conditions and supportive monetary policy, which helped fuel the boom in real assets, 2022 brought geopolitical uncertainty and rampant inflation, with central banks aggressively hiking interest rates in a bid to counter the latter,” said Daniel McHugh, real assets chief investment officer at Aviva.
“There were few places for investors to hide as global equity and bond markets tanked in unison. Many parts of the real assets universe held up relatively well for much of the year, but were by no means immune from the fallout. As the year came to a close, we were starting to see evidence of some assets seeing significant repricing, such as commercial real estate.”
“Throw into the mix the backlash against ESG – a seriously misguided development in the face of climate change, biodiversity loss and social inequality – and, yes, 2022 was quite the year.”
The “sea change” in attitudes towards ESG and sustainable investment approaches – though less prevalent in North America – has “perhaps been the biggest structural trend” in investments in recent years, and one that has extended to the real assets space. Nine out of ten institutions in the Aviva survey now consider ESG a factor in investment decisions involving real assets – but “beliefs over the importance of sustainable investing are running slightly ahead of perceptions of the impact potential of sustainable real assets”.
“Two-thirds of our respondents reported their organisation has a responsibility to invest sustainably, but only one half believe real asset investments can have a more direct ESG impact versus listed equities and credit,” the Aviva report says.
“For institutions drawn to sustainable real assets, key motivations include alignment with corporate values (60 per cent), risk management (58 per cent) and increasing evidence of improved financial performance from investing sustainably (54 per cent). Meanwhile, greenwashing (52 per cent) represented the biggest material risk to investment in sustainable real assets. High valuations (44 per cent) and difficulty in evidencing or measuring positive impacts (43 per cent) completed the trio of top-ranked risks.”
The use of real assets to create positive ESG impacts has also risen, from just 17 per cent in 2019 to 28 per cent in 2022. But regional preferences “are pronounced”, and the pace of change varies considerably. Around 35 per cent of European investors and 31 per cent of Asian investors named positive ESG impacts as a primary reason for allocating to real assets (up from 19 per cent and 22 per cent three years ago), while just 10 per cent of North American investors highlighted this as a driver, compared to nine per cent in 2019.
“Reflecting a narrower return-focused mentality, North American institutions set greater store (40 per cent) in the illiquidity premium and uncorrelated returns associated with real assets than their European (27 per cent) and Asian (26 per cent) counterparts,” the report says.
