Allocations to real assets by asset owners globally are increasing in light of the outlook for inflation, but the performance of the entire asset class won’t be linear nor will it be predictable, Harsh Parikh, a principal in the institutional advisory and solutions group at PGIM explains.
Different assets will have different sensitivities to inflation and economic growth variables depending on investment horizons and economic environments, Parikh outlined.
Allocations to gold, for instance, might be increasingly discussed as an inflation hedge within investment teams, but the extent to which gold and gold proxies make their way into portfolios will depend on a fund’s respective time horizon and economic views, Parikh said. Investor disclosures in the United States in the last year have revealed increasing gold allocations among the largest pension plans compared to historical allocations.
Real assets with higher inflation and growth exposure such as energy commodities, natural resource equities, real estate and REITs, infrastructure equities and timberland might be coveted by funds and schemes worried about an overheating environment, Parikh noted.
Meanwhile, funds with more concerns about stagflation might be more interested in farmland, gold, infrastructure, natural resource and real estate debt, he said.
“The biggest risks [investing in real assets] are in some of the portfolio construction aspects; not aligning the investment objectives and using a broader real assets basket as well as also not property aligning with investment horizon,” he said.
Getting the sensitivities right is one of the four important principles CIOs and investment teams should consider when building and augmenting their real asset portfolios, Parikh continued.
Alongside understanding sensitivities of each individual asset, Parikh included knowing your time horizon, incorporating estimation uncertainty and reflecting your own individual economic environment outlook as the other important principles to consider.
Relying on averages and generic time horizons can hamper decision making around real asset portfolios, he said. Using off the shelf benchmarks can be problematic for funds building their real asset allocations too, he added.
For instance, a CPI [consumer price index] beta for commodities might imply a 11 per cent up-move for every 1 per cent increase in inflation, but that up-move might range from 8 per cent to 14 per cent with 90 per cent confidence, he explained.
“CIOs looking for inflation protection would rather have assets with sensitivities that are more certain rather than assets that have less certainty,” he noted.
Allocations to real assets among pension funds globally have increased between 10 to 15 per cent in the last decade, Parikh noted siting PGIM’s Institutional Advisory & Solutions research on the topic.
Real estate is still one of the dominant real assets as a proportion of this increasing interest, he added, drawing on the PGIM insights. Average allocations to other real assets including to natural resources, infrastructure and farmland have also increased risen from 2.5 per cent to 5 per cent in aggregate during this timeframe, he noted.
Baseline inflation expectations have risen to 2.3 per cent for the next decade compared to 1.7 per cent for the last decade, Parikh noted.