NZSuper, Future Fund look to alternatives amid inflation

Investors have increasingly looked towards alternatives and real assets in the low-yield environment of the past few years, but now there is another reason to include them in a portfolio: they are a decent hedge against inflation.

“We have always had a decent book of real assets, but we found that the alpha outcomes for real assets had been historically extremely strong, and the alpha has perfect inflation pass-through,” Ben Samild, deputy chief investment officer of Australia’s Future Fund said during a panel discussion at AsianInvestor’s Asian Investment Summit last month.

Earlier this year, the Australian sovereign wealth fund unveiled a refreshed investment strategy and said it intended to grow its property investments but did not have a target for allocation.

“We have a range, we tend to operate across all different asset classes and property is no exception. We know we’ll never hit the exact middle of that range, but we know the direction we want to go and the direction is up,” David George, deputy chief investment officer for public markets told AsianInvestor in January.

Similarly, New Zealand Super has been striving to build its allocation to real estate and infrastructure, Charles Hyde, head of asset allocation said during the panel.

“This is motivated in part by the defensive nature of these kinds of assets. But at the end of the day, it's got to deliver sufficient return, and these assets can deliver quite attractive returns,” he said.

“We were targeting real estate and infrastructure at both ends of the spectrum, which is to say, both at the core end and the development end of the spectrum where there's development premium, to be harvested from exposure to that development risk.”

“From an inflation perspective, it's the core that really offers the best inflation protection, that's where you see revenues, cash flows being most explicitly linked to inflation,” he added.

ILLIQUID ASSETS

As a long term investor, he believes New Zealand Super has a “good line of sight over liquidity through time” so that the fund will be able to see projects through even through periods of the market souring.

The fund has been investing globally across Europe, Asia, the US and in New Zealand, he said, with “sizable transactions” in supermarkets in Europe and the US.

“Buying supermarkets in Europe, probably more so than the other jurisdictions or regions is where you find the best inflation protection in the sense that it's more common to see inflation explicitly tied to rental increases in Europe. So that's been quite a nice feature there,” he said.

In the US, the fund has exposure to warehouses, grocery real estate and data centres, while in Asia, it has invested mostly in logistics.

Regarding infrastructure, the fund has been focused on the energy transition and digital.

“So investing into those new renewable energy sources, which will replace fossil fuels eventually, for example, we invested in the Copenhagen infrastructure partners, energy transition fund… But the infrastructure strategy more so than the real estate strategy is more oriented towards taking on that development, risk exposure. And there really isn't a lot of inflation protection to be had there,” he said.

Being able to tide through down markets is important and investors must be prepared for a range of growth and inflation environments, Cameron Systermans, senior portfolio manager for Asia at Mercer said during the same panel.

“All of those things [real assets and private debt] are typically quite illiquid asset classes… Often by the time that your commitments are drawn down upon, inflation has already [come and gone]. So be prepared and be proactive there.”

He also pointed out that while real estate and infrastructure have inflation-linked cash flows that are beneficial, those cash flows are “somewhat offset by the impact that higher inflation can have on discount rates, and therefore the valuations of those assets.”

PRIVATE DEBT & GOLD

The investment manager has also used private debt and gold to hedge against inflation. Private debt is particularly interesting “given that the coupons are typically adjusted with reference to short-term interest rates, and so they'll typically be going up in periods of rising inflation.”

READ ALSO: Private debt promises better gains for asset owners in low-yield environment

“There's not really a lot of asset classes that would perform well in that environment,” he admitted, but gold has been proven to improve portfolio resilience, he said.

“Inflation-linked bonds would perform a similar function in that sort of environment. But they're, compared to gold, relatively sensitive to changes in real yields. Gold is not immune as well, but it is better placed to perform better going forward.”