Market views: Which alternative assets can best withstand inflation?

Inflation and stagflation continue to be a concern for investors amid the Russia-Ukraine war, supply chain disruptions and rising energy prices.
Market views: Which alternative assets can best withstand inflation?

As institutional investors continue to keep a watchful eye on inflation, they are increasingly looking to alternative assets such as real estate, infrastructure and commodities to hedge their portfolios.

Asset owners have named inflation as one of their biggest concerns in 2022, with Asian investors more likely to implement inflation mitigation changes in their portfolios.

Inflation and stagflation have been a legitimate concern in recent months, and even more so in the near future amid the Russia-Ukraine war, supply chain disruptions and rising commodity and energy prices.

The Consumer Price Index (CPI) in the US hit another high of 8.5% in March, a level not seen since the 80s. While many Asia Pacific markets have been spared similar numbers, Australia reported on Wednesday (April 27) that headline inflation for the first quarter of the year was 5.1%, up from 3.5% the previous quarter.

Yesterday (April 28), the Monetary Authority of Singapore warned that headline inflation in Singapore could hit a peak of 5-6% in the third quarter of 2022.

Real estate, commodities and infrastructure have emerged as some of the more popular alternative assets that institutional investors have eyed as a hedge against inflation.

A survey released earlier this month (April 11), found that nearly 70% of asset owners in Asia planned to increase exposure to infrastructure over the next 12 months, and 41% plan to allocate more to real estate.

AsianInvestor asked fund managers if alternatives had become overly expensive and where asset owners can find alternative assets for protection against inflation.

The following responses have been edited for brevity and clarity.

Henry Chui, managing director and head of private wealth, Asia Pacific

Henry Chui

Prices of assets moving up alone is not necessarily a representation of a bubble so investors need to ask what are the fundamental reasons driving prices higher.

Taking a look at real estate as an example of an alternative asset class, there has been an insatiable demand for properties in the industrial, healthcare, and housing sectors because of strong demand and limited supply of stock together with an overall strong macro picture of low unemployment and GDP growth, particularly in the US.   Even with higher inflation now being part of our everyday lives and will most likely be with us in the near to medium term, it is difficult to see these powerful tailwinds in the real estate sectors abating because this is also an environment that landlords continue to have pricing power.

However, investors can be opportunistic and nimble in their approach in order to maximise on these trends.  For example, a nimble manager is able to pick off the best assets instead of just acquiring large portfolios if they are deploying capital into a hot sector like single family rentals.  Similarly, a manager with the operational know how can also develop new supply into this market where prices are currently trading above replacement costs where a good example of this is in life science properties.

Wenting Shen, multi-asset solutions strategist, Asia Pacific
T Rowe Price

Wenting Shen

Inflation is one of the biggest risks facing investors in 2022, made worse by the surge in energy and commodity prices that followed Russia’s war on Ukraine. Many nominal asset classes, including traditional stocks and bonds, tend to directionally compensate for expected inflation—sometimes better than inflation-sensitive assets. However, these nominal assets typically suffer from drawdowns during periods when inflation surprises to the upside.

Our research found that a mix of commodities producers (mining, energy, and utilities) and real estate companies, blended together as “real assets equities,” can work well in an inflationary environment. Historically real assets equities responded more favourably to periods of high or rising inflation than the broad equity market, where returns were relatively weak. Moreover, real assets equities also exhibited similar—and in most cases, superior—inflation sensitivities to traditional inflation-linked bonds. A strategic allocation to real asset equities could potentially smooth real returns and diversify the portfolio for asset owners through inflation regimes.

Benno Klingenberg-Timm, managing director, head global sovereign markets Asia Pacific
UBS Asset Management

Benno Klingenberg-Timm

The writing has been on the wall for some time; the current reflationary environment is not a surprise to many institutional investors. Since late last year, sovereigns, pension funds and insurers have told us that they are pushing the boundaries to identify assets and themes that can be reasonably expected to show a higher degree of resilience amid a volatile and inflationary environment.

We have seen interest in real assets, especially those with distinct sustainability characteristics like energy storage facilities. These assets are essential in the renewable scene and are now at a tipping point where costs have fallen significantly while receiving strong regulatory support.  We also continue to have conversations in the food and agricultural space especially in cold storage facilities and farmland.

The other strong area of interest in alternatives is in multi-strategy hedge fund that is fundamentally driven.  The relative value investment discipline in hedge fund investing works across different macro risks geopolitical instability and economic or policy challenges, provided those risks are understood and accounted for by investors.

While headlines on China continue to be challenging, many institutional investors understand the importance of keeping a long-term allocation there and are expanding on that opportunity through a long/short approach.

Cameron Systermans, senior portfolio manager

Asset owners should have a strategic allocation to inflation protecting assets given that timing inflation can be challenging, particularly where strategies are implemented through illiquid assets. By the time high inflation is priced into the market, valuations of inflation protecting assets may be already bid up.

Nevertheless, in addition to mainstream assets like inflation-linked bonds, alternative assets such as infrastructure and real estate can provide protection, given inflation-linked cash flows. However, this is partially offset by high valuations for core assets, and higher inflation flowing through to higher discount rates. Private debt is another option for inflation protection as coupons are usually adjusted with reference to short term interest rates. Gold is also effective in risk asset hedging, but is vulnerable to higher real interest rates. The key message for asset owners is to be prepared for inflation long before it arrives.

Hui Min Ng, director and portfolio manager, equities
Manulife Investment Management

Hui Min Ng

We believe higher inflation and an increase in rates driven by economic growth is a net positive for physical assets. Under these circumstances, real estate fundamentals remain supportive, and this sector provides a great opportunity for an income investor to consider a hedge to inflation. As global Covid cases stabilised in recent weeks, we continued to believe that a synchronised global reopening should provide further upside for REITs, especially for the retail, office, and hospitality sectors.

In our view, the fundamentals of REITs remain the key driver to the AP REIT strategy. The long-term fundamentals of REITs are driven by local economic dynamics as opposed to global macro and geopolitical risks. Factors such as supply and demand, occupancy trends, rental outlook, and tenant profiles are more important to a REIT’s ability to generate and grow net property income and subsequently, dividends.

Sergey Pergamentsev, head of institutional, structured management, multi asset, quantitative and solutions
BNP Paribas Asset Management

Most of our loans are floating rates and financing infra/real estate projects or companies with revenues which should be protected against inflation. Inflation may push rates higher and the floating rates loans we invest in should reflect that. A lot of investors have been switching to floating rates from fixed rates and the trends is likely to continue.

Some areas of the markets are particularly hot. Projects in specific sectors in major investor themes have attracted huge amount of capital and these projects have become more expensive, namely; energy transition, renewables, green mobility, digital assets, logistics – which are not specifically related to inflation.

Ultimately, seeking good inflation protection is challenging in terms of the goal and the tracking error even if one ignores for a moment the expensive prices. The idea often is to construct portfolios that provide a “good enough” inflation-like exposure (for instance through floating rates) using diverse assets and by choosing attractive opportunities at every given moment. Flexibility and access to the necessary markets is key here.

Paul Fraynt, head of alternative risk premia
K2 Advisors

Paul Fraynt

Inflation expectations have repriced dramatically since the end of 2021. Fed Fund Futures have priced in 185bps of additional rate hikes in 2022, while one-year inflation expectations have jumped from 3.7% to 5.4%, well above 2% target rate. Central banks are behind in tightening financial conditions, forcing market expectations to race ahead. A lot is priced in and given the recent fundamental shift within the Fed to refocus on inflation rather than full employment, the easy money has arguably, been made. For investors seeking an inflation hedge, we would recommend strategies with self-adjusting risk mechanisms. Rates Trend, particularly in STIR futures, could help align positions with changes in monetary policy, while commodity momentum could help address stagflationary concerns. Even direct exposure to inflation-linked swaps can be added in a risk-conscious manner by dynamically replicating exposure of an OTM call. Such tools can help position investors for a multitude of scenarios.

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