(Bloomberg Markets) -- A rocky 2022 has left investors with plenty to worry about, so asked some experts where they’d safeguard money over the next 10 years. Their responses have been edited for clarity and length.
High-quality, well-located real estate has already acted as a store of value for just about all of modern history, and it is well-placed to continue to do so. Commercial real estate offers predictable and growing contractual lease income, protection against inflation as a real asset, lower correlations with other asset classes and durability against social, economic or technological change. While the specific geographies and property types offering the best risk-adjusted returns can and do evolve, the core purpose of real estate—to facilitate shelter, collaboration, entertainment or commerce—will always be relevant. One of the best ways to access real estate is via the public REIT [real estate investment trust] market, which at the moment happens to be quite dislocated relative to private real estate funds, who often own lower-quality assets and operate with much riskier capital structures. This makes now an opportune time, in our view, to establish an allocation to real estate via listed REITs for the next decade and beyond.
On asset classes over the next decade, our anchoring assumption is that inflation will remain at more elevated levels due to structural shifts including de-globalization, falling productivity and supply constraints (labor, etc.). As such, real returns will be imperative, as they are the best stores of wealth. In asset allocation terms, the following spring to mind.
Equities of companies in sectors with sufficient pricing power, be it utilities or pharma. They will be best insulated from inflation, but there will be regulatory risk. I am all for growth/tech as well, but cost of capital will be higher, so we need to manage expectations. I don’t think we will see them dominate as much as they have over the past decade. Note: There are tech firms that behave like utilities as well, such as cloud providers, and they will do better than “pure growth” types.
FX: Countries willing to maintain positive real rates. Latin America is showing the way, and there may be some good prospects in Southeast Asia, such as Indonesia.
Credit: This is probably the toughest asset class over the next decade, as markets shun debt and positive real rates will also prove problematic. However, we can already see the uplift in bank earnings, which means the risk premium on financials established during the global financial crisis will be eroded. As a result, a lot of the subordinated debt and CoCos [contingent convertible bonds] like AT1s [additional Tier 1 bonds] will be re-rated. Hopefully tighter regulation will also prevent a repeat of 2008, and that is a part of the re-rating process.
I think 10-year Treasuries will be the best store of value over the next decade. I emphasize “store of value” (Treasuries have no credit risk, and I believe that the US government will pay its bills) and “next decade” (the Fed is moving real rates high, but at 1.75%, I think 10-year real rates are very restrictive and that will slow the economy over time). A 10-year risk-free real rate of 1.7% is attractive in my mind. It is a great offset to any risk asset in one’s portfolio. The 10-year Treasury should incorporate the views on fed funds over the next 10 years. While the Fed will be slow to start easing due to sticky and high inflation, we think that once they start to ease [monetary policy], they will cut very aggressively. I think the next downturn will be long, even though it may not be very deep. So, it will ensure low fed funds rates. Also, QT [quantitative tightening] has been a big part of the move higher in rates, and we expect that to end in Q4 2023 once the Fed starts to ease rates. I think every investor also needs some Treasuries as a store of liquidity, as high volatility and unprecedented hikes will pressure different asset classes and business models. Having Treasuries which are relatively easy to sell would be a benefit in case of any deleveraging pressures.
We have had a significant move higher [in 2022] in both interest rates and corporate debt spreads. High-yield corporate bonds and loans will generate high single-digit annual returns over the next decade, which will turn out to be very competitive and possibly even exceed private equity returns. Corporate bonds and loans provide a higher certainty of return than equities with contractual interest income and a final maturity. I acknowledge that defaults are rising and that some companies may be challenged with higher interest payments and less free cash flow.
As a cash substitute today, short-term US Treasury bills offer far superior returns to bank savings accounts and bank CDs [certificates of deposit] along with great liquidity. Not sure how long this opportunity will last.
From an asset allocation perspective, 3% to 3.5% inflation means lower multiples on equities. It means we’re going to have sustained higher bond yields. It probably means higher spreads on credit. And it’s also a tougher environment for private equity, which relies on a lot of leverage. I don’t think private equity will be a bad investment, I just think the manager selection will be a lot more important. And, last but not least, it’ll be an environment with a lot of dispersion, which should be good for more hedge-fund-oriented investments. Also, in a higher-inflation environment, you’d expect infrastructure assets and other real types of assets to do quite well.
From my perspective, the “best store of value” question isn’t the same as the “best opportunity/highest-returning asset” question. I interpret “store of value” to be consistent with stability and preservation of capital. I think TIPS [Treasury Inflation-Protected Securities] at current levels have to be considered one of the more compelling stores of value. Here’s why: A holder of TIPS receives the real yield, plus the change in the consumer price index (CPI). Obviously, one of the most significant unknowns right now is inflation. Clearly the inflation we witnessed from the Covid economic disruption wasn’t simply transitory. But just how persistent will it be going forward? While housing data suggests we might be at or approaching an inflection point, the labor market and certain segments of the service economy are telling us a different story. With TIPS, an investor can take the inflation debate out of the equation and take comfort in earning a current real return of nearly 2%.
We haven’t seen real yields this high for over 10 years. The value proposition of TIPS is further enhanced by the fact that many of these securities are trading at a discount to par. Investors receive the CPI component of their return based on par, not based on the actual dollar price they pay. In other words, an investor who purchases a TIPS bond at 80¢ on the dollar is receiving a CPI payment based on 100¢ on the dollar.
There are three solutions to the problems of inflation, debasement of currency, political and geopolitical risk and environmental risk.
Solution No. 1 is to have very, very short-term Treasuries that adjust in rates and don’t have the price action of long bonds.
Secondly, you want to be in TIPS, even if TIPS have not yet done well because inflation expectations are not yet de-anchored. And I think you want to go into gold and precious metal. Again, gold has not done well because you have tight monetary policy and a strong dollar. But if central banks are going to blink and wimp out, gold is going to rise in value. Gold is going to rise in value also because the enemies of the US are subject to sanctions. China right now is worried they have a trillion dollars of reserves in dollars that they have to move to other things. If it’s euro, yen, it can be seized. The only thing that cannot be seized is gold. Of course, not in the vault in New York or London, but in Beijing or Moscow and so on.
And finally, appropriate types of real estate that are environmentally resilient, because real estate compared to equities in a recession does well—you have more pricing power for rents and so on. So, a combination of these assets provides you in an optimized way a hedge against some of these tail risks.
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