Q&A: Brookfield on alternatives, inflation and information asymmetry

Infrastructure and real estate assets are gaining asset owner attention because their combination of predictable cash flows and relatively low risk, suggests the investment firm.
Q&A: Brookfield on alternatives, inflation and information asymmetry

A low-interest rate environment has driven the rise in popularity of alternatives investments among asset owners looking for more stable income yields and diversification, a top executive at alternatives expert Brookfield told AsianInvestor.

The trend is expected to continue as Asia-based asset owners said they plan to increase allocation to alternatives over the next six to 12 months, according to data collected by Asset Owner Insights (AOI), an AsianInvestor data intelligence platform.

Niel Thassim

More than half (56%) said they planned to increase future allocations to private equity, and 60% said they would increase capital on infrastructure investments.

For instance, Korean life insurers, including Samsung Life and DGB Life, are looking to diversify into overseas private debt, while high-net-worth investors are set to double their alternatives allocations over the next three years.

Niel Thassim, managing partner and the Asia Pacific head of Brookfield’s private funds, tells AsianInvestor why asset owners have been increasingly interested in alternative assets, where the best opportunities are in Asia Pacific, and his approach to inflation rate concerns.

How much have institutional investors (particularly asset owners) grown in their receptivity towards alternative asset classes over the past three years?

A decade ago, institutional investors allocated around 10% of their portfolios to alternative investments. Today, it's closer to 20 to 30%. And it's trending towards 50%.

There are some specific reasons that we're seeing this, which have become even more pronounced over the last year or two. And the first is that alternative assets have the potential to be attractive alternatives to traditional fixed income and equities portfolios.

So on the fixed income side, certain alternative assets provide a higher, longer duration and more stable current income yields, than traditional fixed income portfolios, and that's become very important in this low interest rate environment. And on the equities side, certain alternative asset classes have the potential to provide a lower risk, total return exposure compared to the more volatile traditional equities portfolios.

The second reason is the diversification benefits. Not only are alternative assets, lowly correlated with fixed income and equities, but they're in fact lowly correlated with themselves. So for example, what drives real estate cycles in Australian student accommodation is very different to what drives the real estate cycles for Chinese logistics assets or UK office assets.

Related stories:

How concerned are you about inflation rates – are they transitory or will this affect asset prices in the long-term?

Clearly a large part of the economic activity at the moment is being driven by the enormous amount of stimulus from governments and central banks around the world. And the real question is whether that is a short term blip? And will it normalise back to low levels of economic activity, or will that self-perpetuate to more and more economic activity over the medium to long term?

And in both of those instances, there's going to be different types of inflationary impact.

What are some trends you have noticed in asset owner requests for alternative assets?

The low-interest rate environment is incentivising a lot of investors to look for stable, predictable cash flow, income yielding sectors that provide an attractive spread to traditional fixed income portfolios. And the lower risk of both infrastructure and real estate sectors provide a very good solution for that.

At the other end of the spectrum, we're seeing meaningful amounts of information asymmetry and uncertainty in markets, and dislocation in certain sectors, which is giving rise to the opportunity – for those investors that can take advantage of information asymmetry – to generate attractive returns coming out of the post Covid recovery. And again, real asset and real asset-related businesses are attractive places to invest in when you can take advantage of information asymmetry and market dislocations.

Could you explain a little bit more about this information asymmetry? What is it, and what do you mean by that?

One thing that people often forget around alternative assets and real assets in particular is, it's not a thematic play. It's not an asset allocation play. Real assets are operating assets and operating businesses. And the alpha that's generated comes from the actual operations.

As an example, there might be a general thematic perception, around Covid, that Covid has driven a perpetual work from home trend, and that no one's going back to officesbecause most people are going to be working from home. If you take that thematic, you miss the point that individual office assets don't operate as a commodity. They're not all the same.

And so a high quality, competitively located brand new office building, right in the heart of a gateway city like Sydney, or Shanghai, is going to perform very, very differently from an obsolete, antiquated B-grade office in a third or fourth tier city.

How have local regulations and capital requirements affected your strategies across different markets?

Specifically, there's probably three regulatory trends that we've seen that have that are having more meaningful impacts on alternative investing around the world.

The first is local foreign investment regulations in certain markets, which directly impact global capital…The second is competition regulation, particularly with respect to critical infrastructure, like energy assets, water assets, telecommunication assets, and being across how competition regulation in certain markets where these types of backbone infrastructure tend to have monopolistic or oligopolistic profiles.

And then thirdly, is regulations around sustainability. Governments all around the world, are designing, passing and implementing ESG and climate change regulations. And these policies will fundamentally change the way real assets are being invested built and operated. And more importantly, I think those assets and companies that don't adapt to these changing sustainability, climate change regulations, are going to run the real risk of becoming obsolete very, very quickly.

Do high capital flows into alternative assets cause an inflation impact on prices? How much of a concern is this?

There is just an unprecedented amount of capital being allocated into the alternative sector. And so it's natural for investors to worry and to ask the question: 'is there just too much capital chasing too few deals, and is that going to result in unrealistic and unsustainable pricing?'

In our view, that misses the other side of the equation. The real worry, from our perspective, is that there's not enough capital for all of the investment demand that's required by alternatives in real assets sectors around the world.

I'll just give you a couple of examples. There is just huge amounts of capital required by developing countries in Asia and globally, to fund the unprecedented expansion of backbone infrastructure to support urbanization, growing middle classes and growing consumption. Equally, there's just as much capital required by developed economies to upgrade old, antiquated and obsolete infrastructure, particularly in the post-Covid world.

And finally, I think the most significant ... demand supply mismatch in alternative assets is [centred on] climate change. And the world is only just coming to grips with this, but there is going to need to be hundreds of billions of dollars required to decarbonise the global economy.

How do you overlay ESG considerations onto alternative asset investments?

We don't see ESG as an overlay. We see that it is, and it should be, embedded into every aspect of what we do, not only how we invest , and how we manage the investments, but how we, as an organisation, interact with ourselves and with our communities. It's embedded into everything.

We've certainly observed ESG strategies globally evolve from negative screening strategies to positive screening strategies to impact investing strategies. Negative screening strategies traditionally were investors who avoided investing in sectors such as dirty energy or weapons. That then evolved to positive screening strategies where investors would say, 'well, we're only investing in renewable power or we're only investing in social housing'.

And that has now evolved from positive screening to impact investing, where the capital invested and the expertise becomes a catalyst to positive change, positive ESG change. And we think that's going to not only be one of the most important transformations in the alternative investment sector, but it's going to provide huge commercial value for investors over the next two to three decades.

At Brookfield we've applied all three of those ESG strategies, negative screening, positive screening and impact investing into everything we do. But most recently, with the appointment of [former Bank of England governor] Mark Carney as a vice chair of Brookfield, we're particularly focused on impact investing, and the positive changes we can make and value we can generate from decarbonising the global economy.

¬ Haymarket Media Limited. All rights reserved.