The past year witnessed a significant spike in volatility as the health of the global economy faced uncertainty. Global markets struggled with concerns over growth and stability in China, emerging market weakness and currency devaluation, recession in Japan and the continued need for inflation-targeting policy in Europe. And while the US economy appeared to be the relative picture of health, the equity markets continued to focus on decisions by the Federal Reserve Board (the Fed) and depressed commodity prices.
Even with these macroeconomic cross currents, favorable underlying strength of commercial real estate and infrastructure fundamentals continued throughout calendar 2015. Returns for real estate equities were consistent yet below the broader indices, while returns for master limited partnership (MLP) and infrastructure equities were dramatically lower.
What might 2016 have in store?
- The tempered macroeconomic growth environment, manageable levels of new commercial construction and the “lower for longer” interest rate outlook currently embraced by many forecasters should provide a fairly supportive environment for both commercial real estate and infrastructure, in our view. For many of the companies in which we invest, underlying cash flows remain stable-to-growing. However, share prices and investor sentiment were anything but stable in 2015. The year may bring another dose of share price volatility in spite of healthy company operating performance.
- The Fed’s pace and timing of additional tightening of monetary policy will likely impact asset prices. History shows that investors typically overreact to interest rate increases and reduce exposure to income-related investments including US real estate investment trusts (REITs). This volatility has traditionally paved the way for US REITs to outperform in the year following the initial market reaction.
- Additional stimulus by the European Central Bank and the People’s Bank of China is likely to result in a stabilization of economic growth, albeit at lower levels than in recent history. This would have the greatest impact on our global real estate and global infrastructure portfolios.
- Growing capital needs within the public sector may increasingly result in the privatization of large scale infrastructure projects, such as the redevelopment of New York’s LaGuardia airport or the infrastructure concession programs in Sao Paulo, Brazil, and throughout Japan.
- The 2015 budget cuts by energy companies should continue to slow US oil production, and inventories should fall in 2016, helping to stabilize the oil price environment. This could bode well for MLPs, which have been battered despite their traditionally low correlation to commodity prices and the contractual nature of their cash flows.
- Geopolitical events remain top of news and are extremely difficult to forecast for either their occurrence or their impact on global capital markets and investment returns.
Taking advantage of volatility
With so many macro cross currents in mind, where do we see opportunity? We believe investors should:
- Remain focused and committed to their long-term strategic asset allocation. If the market over-reacts to short-term events, rebalancing portfolios may help take advantage of such movements.
- Examine the types of investments that may improve portfolio diversification. Companies that own commercial real estate and infrastructure assets typically offer long-term stable cash flows and have historically paid attractive dividends that outpace inflation. Many of these long-term contractual cash flows in which we invest are insulated from short-term economic bumps in the road.
If investors remain committed to strategic objectives and fundamental decisions during 2016, there is a good chance that market volatility can work in their favor.
Read more in our 2016 investment outlook series.
Important information
Diversification does not guarantee a profit or eliminate the risk of loss.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
Investment in infrastructure-related companies may be subject to high interest costs in connection with capital construction programs, costs associated with environmental and other regulations, the effects of economic slowdown and surplus capacity, the effects of energy conservation policies, governmental regulation and other factors.
Most MLPs operate in the energy sector and are subject to the risks generally applicable to companies in that sector, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk. MLPs are also subject to the risk that regulatory or legislative changes could eliminate the tax benefits enjoyed by MLPs which could have a negative impact on the after-tax income available for distribution by the MLPs and/or the value of the portfolio’s investments.
