Strength in real assets to continue – 2016 outlook

Global investor demand for real assets – including infrastructure equity, infrastructure debt, listed infrastructure, listed real estate and direct real estate – is expected to strengthen this year, with a number of themes set to influence this sector. In this article, we discuss these themes in relation to the particular assets.

AMP Capital’s infrastructure and real estate managers are forecasting continued strength for these real asset classes in the coming year.

Themes that will influence the performance of the assets include:

• Competition for ‘trophy’ (or resource rich) assets and high-quality Australian property

• The US Federal Reserve’s movements on rates

• Increased merger and acquisition (company consolidation) activity and privatisation

• A ‘lower for longer’ yield environment

• Urbanisation and infrastructure spend

Below we discuss how these themes will strengthen investor interest in these real assets and drive growth.

Direct infrastructure – equity

Global Head of Infrastructure Equity, Boe Pahari

Infrastructure is a defensive asset class that’s highly competitive. This competition will continue to intensify during the next 12 months as more funds are launched by a greater number of managers. There is more money than ever before to invest in infrastructure. In addition, we are seeing a growing preference from large investors, particularly sovereign wealth funds and pension funds, to invest directly in infrastructure assets. This increased activity across the asset class is putting upward pressure on pricing across most sectors, particularly large energy, utilities and transport assets. However, AMP Capital’s middle-market strategy means we try to avoid the ‘trophy assets’ that attract the highest level of competition, and deliver enhanced returns by targeting more proprietary opportunities.

Looking to 2016, we believe deal flow will remain highest in the largest and deepest infrastructure markets of Western Europe and North America, although we are seeing more and more investors looking to Eastern Europe for value due to the competitiveness of deal flow in other regions and subsequent pricing pressure. Investors are continuing to recognise the value in infrastructure’s attractive combination of stable yield and strong potential for capital growth. While we continue to see a preference amongst the largest investors to invest direct directly in assets, unlisted funds still remain the preferred route to market for the whole investor universe.

Direct infrastructure – debt

Global Head of Infrastructure Debt, Andrew Jones

We expect 2016 to provide a strong pipeline of investment opportunities in the infrastructure debt space with merger and acquisition activity and privatisation programs driving activity around the world. In the senior debt space, we expect liquidity from banks to continue to drive returns lower as competition for high-quality assets continues. In the less competitive mezzanine space, we expect returns to continue to be attractive, particularly on a risk adjusted basis. Investors in infrastructure debt are looking for investments with high yield and stable returns.

Sectors where we anticipate strong activity and investment opportunity during 2016 include the energy sector in the US, where continued market volatility is creating deal flow, and a strong pipeline of regulated opportunities across Europe. Our sweet spot will continue to be assets in utilities, energy and transport in OECD countries.

Listed infrastructure

Global Head of Global Listed Infrastructure, Tim Humphreys

Next year is shaping up to be an interesting time for financial markets as the post-Global Financial Crisis bull market faces a key test: dealing with the US Federal Reserve’s rate decisions. Some people believe low short-term interest rates have been positive for financial markets and higher rates will therefore be negative. But markets are not this simple and as long-term investors we are more focused on the long-term borrowing cost and cost of capital.

Much focus has been on the changes in the global oil market and the ‘lower for longer’ crude oil environment, but our view is that we are in a ‘lower for longer’ yield environment globally and despite an inevitable first rate hike, we think the Fed will be cautious not to go too far as the rest of the world is still weak. Our view is that the strong demand that we’ve experienced over the past decade for real assets that offer high and sustainable yields will continue in 2016.

Direct real estate

Global Head of Property, Carmel Hourigan

Unlisted commercial property still provides a very compelling investment proposition, particularly in Australia. While cap rates continue to compress to historically low levels, Australian real estate remains relatively attractive compared to other global markets and asset classes and the income return alone is very compelling. Capital markets will continue to be the most significant driver of investment performance during the next 12 months. Demand (particularly from offshore investors) for high-quality Australian real estate is insatiable. The fall in the Australian dollar has only served to make Australian real estate more attractive. The big differentiator to the last cycle is the fact that it’s generally equity, not debt, driving pricing. However, high quality real estate is in limited supply and hence landmark ‘portfolio’ transactions are commanding a lot of interest with a lot of domestic players priced out of the race. With major institutional investors from Japan, China and Norway yet to put a toe in the water in Australia, we expect capital markets to remain deep for some time yet.

Double-digit returns from unlisted core funds are likely to continue for a little longer but funds need to be positioned for the next downturn. We have been divesting non-core assets to ensure portfolios are defensively positioned both in terms of asset quality and location. Going into 2016, we have a strong bias to Sydney and Melbourne office, and high quality regional shopping centres.

Listed real estate

Deputy Head of Global Listed Real Estate, James Maydew

Europe is extremely attractive; it’s in the early phases of significant monetary stimulus. Hard assets with contractual income are well positioned to benefit from this and listed real estate fits that criteria. We see great opportunity in certain core German cities – due to strong urbanisation, immigration and net household formation – and Spanish office. We expect certain Spanish markets to have some of the fastest growing rents in the world over the next three years.

Merger and acquisition is also likely to ramp up in 2016 globally as US Fed rate hikes create volatility and dislocation in the markets. This will present companies with a strong balance sheet and cost of capital to acquire publicly listed real estate trading at discounts to the direct market, given the ongoing arbitrage between the private and public markets.

Urbanisation and infrastructure spend in global, gateway cities is also a strong theme. Companies with assets or development expertise in markets positively impacted by this structural trend will continue to benefit in 2016 as rental values grind higher. London West End, Mid/Downtown Manhattan and Central wards of Tokyo are large beneficiaries of this momentum, and can be accessed via retail, office and residential depending on the city or infrastructure project. In Japan, there is also value in the lodging sector, given the country is preparing for the Olympics and the Rugby World Cup during the next four years and the government has an explicit target to increase international visitors.

AMP Capital 27 January 2016

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.