Real assets: A sought-after investment class in times of crisis

Current Issues Global financial markets June 6, 2012 Authors Josef Auer +49 69 910-31878 josef.auer@db.com Eric Heymann +49 69 910-31730 eric.heymann@db.com Jochen Möbert +49 69 910-31727 jochen.moebert@db.com Claire Schaffnit-Chatterjee +49 69 910-31821 claire.schaffnit-chatterjee@db.com Antje Stobbe +49 69 910-31847 antje.stobbe@db.com Editor Antje Stobbe Deutsche Bank AG DB Research Frankfurt am Main Germany E-mail: marketing.dbr@db.com Fax: +49 69 910-31877 www.dbresearch.com DB Research Management Ralf Hoffmann | Bernhard Speyer Real assets A sought-after investment class in times of crisis Real assets are currently very much in demand by investors. The major drivers of this are the high volatility in the financial markets since the start of the global financial crisis and the concern many investors have about high rates of inflation. Empirical studies show that real assets can actually provide effective inflation protection. For many investors, real estate is the most important real asset investment. Whereas numerous real estate markets in Europe and the USA are still suffering the effects of overheating, rising prices are now evident in the German residential property market. The environment for commercial property also remains attractive. Long-term trends, such as the growth of the global population, increasing urbanisation and the growing economic importance of emerging markets, favour investments in real assets such as infrastructure or agricultural land. Growth in the volume of ships and aircraft is benefitting from growing world trade and increasing international mobility. Low margins, e.g. in aviation, are a risk factor in this segment, however. Numerous investment options in renewable energies. The energy transition in Germany, as well as the increasing use of renewable energy sources in other countries, is creating new prospects for investors in real assets. Although investors have been able to gain considerable experience of e.g. onshore wind, biomass and photovoltaics, with hydroelectric power and, in particular, offshore wind farms they are still entering largely new territory. Individual case analysis is decisive. In contrast to homogenous real asset investments like gold and other raw materials, for heterogeneous real assets such as real estate, ships and offshore wind farms a comprehensive valuation of the investment concerned, its earning potential and risk profile is of major importance. Factors such as an attractive location, favourable market prospects and stable political conditions – also in other countries – play a role in economic success. Investors must also take account of ethical principles, e.g. when investing in agricultural land. Real assets with specific risks. Investment in real assets presupposes a well-informed investor, capable of assessing the various alternative forms of investment. This applies all the more because most real asset investments have a very long investment horizon, they often have low fungibility and/or liquidity and investors frequently have to take entrepreneurial risks. This can even result in total loss of the investment. Real assets: A sought-after investment class in times of crisis The flight for security 1 USD/troy ounce, EUR/troy ounce 2000 1500 1000 500 0 00 02 04 06 08 10 12 A. Real assets: an overview The topic of real assets is currently being intensively discussed in the media and among investors. The turbulence in the financial markets since the start of the subprime crisis in 2007, together with latent worries about inflation resulting from unorthodox financial policies, mean that investors are looking for alternatives to investments in stocks or bonds. Preservation of capital has taken on a new significance. Gold has benefitted from this in the last few years. The gold price has almost trebled, from just over 630 USD per ounce at the start of 2007, to almost 1,800 USD in February 2012 (see Fig. 1). This study discusses the characteristics of investments in real assets (Part 1) and analyses various investment options (Part 2). We have concentrated on categories of investment that are usually illiquid and that are not normally traded in the financial markets. USD Source: DB Research EUR What are real assets? No simple demarcation 2 “Do you consider the following to be real assets?" (%) Real estate Agriculture/forest Gold Precious metals It is not easy to give a clear definition of real assets. The equivalent German term Sachwert refers only to the reproduction value (replacement cost) of a good. In an investment concept, a real asset is defined as a good that is independent from variations in the value of money.1 This definition alone provides sufficient motive for the integration of real assets in portfolios. In times of high inflation, real assets should protect financial resources against loss of purchasing power. Agric. raw materials Fossil raw materials Infrastructure Renewables Water Equities Ships Aircraft Containers Patents 0 20 40 60 80 100 Source: Steinbeis Studie, 2010 It is by no means clear what goods should be included in the real assets group. A current survey shows that more than 90% of the institutional investors who were asked classified real estate, land and forests, precious metals and fossil and agricultural raw materials as real assets (see Fig. 2). The degree of agreement starts to fall in the case of renewable energy, infrastructure, ships or shares. Equities are frequently classed as real assets, because the purchaser of shares acquires an interest in a company. Luxury goods such as clocks, art, jewellery, vintage cars and wine are also often defined as real assets. Here, however, there is a fluid boundary between hobby activities and investment goods: the trend of prices is correspondingly opaque. Equities, luxury goods and patents are outside the boundaries of this study. Open and closed-end funds 3 “Closed-end funds, as financial intermediaries, pool the capital from a number of investors in order jointly to finance an economic good that individual investors could not finance. They therefore offer private investors the opportunity to participate in large investment projects. Unlike equities and open-ended funds, closed-end funds are not involved in financing indeterminate and open-ended projects. The business model is typically centred on a project-or property-related investment, for a defined period, predominantly in real assets.” In some open-end funds, e.g. a real estate fund, by buying a share the investor also acquires economic co-ownership of the fund’s assets. Open-end real estate funds issue a fundamentally unlimited number of shares, which are normally acquired and redeemed on each trading day. Sources: http://www.vgf-online.de/rund-um-fonds.html and http://www.bvi.de/de/investmentfonds/fondsarten/offene_ immobilienfonds/index.html Gold: A special role among raw materials 4 Gold has a special status among raw materials. For centuries it has served as a “money metal”. During the gold standard in the 19th century, paper money was totally or partially backed by gold stored by the central banks. Under the Bretton-Woods system (1944 to1973), various currencies were linked to the gold-backed US Dollar. After the ending of the gold standard, gold still retained a certain importance as a reserve. The central banks worldwide currently store around 30,500 tonnes of gold as currency reserves. In contrast, in 2010 demand from the most important gold importing countries, inter alia for industrial production and jewellery manufacture, was for only around 3,000 tonnes. Fluctuations in the gold price are therefore often caused by strategic changes in the central banks’ reserve positions. However, gold’s role as a “safe haven” in periods of crisis, which has led to the rapidly rising price of gold since 2007, is more important. In comparison, the prices of industrial raw materials and oil are more strongly driven by economic trends. There are various possibilities for investing in real assets. Firstly, direct investment in a real asset is possible, such as the purchase of gold bars, real estate, or a direct interest in a solar installation, a ship or a farm. Secondly, there are various indirect investment schemes. These include open-end and closed-end funds (see Box 3). The acquisition of stock in raw material companies (e.g. gold mines) or real estate equities (REITs, see Box 6) are other 1 Cf e.g. Gabler Wirtschaftslexikon Online. http://wirtschaftslexikon.gabler.de/Stichwort-Ergebnisseite.jsp, viewed on 23.2.2012. 2 | June 6, 2012 Current Issues Real assets: A sought-after investment class in times of crisis Closed-end funds: Lower inflows 5 DE, EUR bn possibilities. Investors can invest in commodities that, unlike gold, are not easy to store, through certificates or index funds (Exchange Traded Funds, ETF). 25 REITs 6 20 15 10 5 0 2000 2002 2004 2006 2008 2010 Equity capital Debt capital Source: VGF Closed-end funds: Real estate particularly sought-after 7 Equity capital placed by asset class, DE, EUR m, 2011 REITs are stock-market traded real estate AGs (joint-stock companies). Investors benefit from their high liquidity, with shares traded on the stock market, and the diversification possibilities of the real estate portfolio. REITS can also be attractive for tax reasons. REITS are internationally established. In the USA, this investment vehicle was successfully introduced as long ago as the 1960s. Since being launched in Germany in 2007, however, this type of investment still has a shadowy existence. Magnitude difficult to gauge Real assets definitely play a significant part in the portfolios of both private and institutional investors. The magnitude of the capital and current investments in real assets can, however, be only roughly estimated as investors – as described – can choose different forms of investment, the market volume of which is often not transparent. The purpose of the investment is also not always clear. For instance, an owner-occupied property is certainly a real asset investment. However, the house owner does not necessarily purchase or build a home with the aim of making a profit. It rather represents a permanent asset or a durable consumer good. For the purposes of this analysis, we assume that investors investigate alternative investments with the aim of achieving a return. 941 2,236 316 415 506 795 637 Other Aircraft Infrastructure Ships Energy Foreign real estate Domestic real estate Source: VGF Ships decline, energy in demand 8 Closed-end funds, inflows, DE, EUR bn The markets for open-end and closed-end funds provide an indication of the general development and trends of investment in real assets. The Verband für Geschlossene Fonds (VGF) estimates that the assets of closed-end funds in Germany are EUR 199 bn (as at 2011). EUR 99 bn of this is invested as equity capital. In 2011, EUR 9.9 bn passed into real assets through closed-end funds in Germany (down 8% yoy, see Fig. 5). The volume has considerably declined since the start of the financial and economic crisis and, since 2009, has been at a low level. Last year, private investors made the vast majority of the equity capital available: EUR 4.81 bn of the total of EUR 5.85 bn. More than half of the equity capital collected flowed into domestic (up 38% yoy) and foreign (up 10% yoy) real estate funds (see Fig. 7). This reflects investors` fundamentally increasing interest in the German property market. Following, by a considerable margin, were Energy (11%), Ship (9%) and Infrastructure funds (7%). Cash flows into ship investment funds have collapsed heavily since 2008; while equity capital investments into energy funds rose in the same period (see Fig. 8). However, in 2011 the latter failed to fulfil expectations at only EUR 637 m (a 23% decline yoy). The fund volume fell by as much as a third yoy. 8 7 6 5 4 3 2 1 0 2000 2002 2004 2006 2008 2010 Private investors have also invested EUR 87 bn (as at 2011) in open-end real estate funds in Germany. However, in the last few years there has also been a decline in net inflows: in 2011 only EUR 1.2 bn, after EUR 1.6 bn in 2010 and EUR 3.2 bn in 2009 (see Fig. 9). Institutional investors have invested almost EUR 33 bn in real estate through open-end special funds (as at the end of 2011). In addition, the Bundesverband Investment und Asset Management (BVI) reported an investment volume of EUR 5 bn by private investors in raw-material-based investment funds (e.g. investments in commodity futures). Therefore at least EUR 125 bn is committed to open-end real asset funds. Energy funds Ship funds Source: VGF Motive: why have real assets in the portfolio? The survey shows that investors have differing motives for investing in real assets. The factors frequently mentioned were diversification, inflation protection, risk reduction and/or crisis resistance and increased yield, or a mixture of these (see Fig. 10). To what extent are real assets appropriate for achieving these objectives? 3 | June 6, 2012 Current Issues Real assets: A sought-after investment class in times of crisis Open-end real estate funds: Stagnating assets 9 EUR bn, retail funds on sale in DE 15 90 10 60 5 30 0 0 -5 -30 Inflation protection Investors favour real assets as a hedge against rising inflation rates. Whereas, in an environment of higher inflation, financial assets such as bonds lose value in real terms, the real prices of real assets remain stable or increase. During the last 15 years, inflation rates in the industrialised countries have fluctuated at moderate levels of up to 3% p.a. (see Fig. 11), although in some countries they have been considerably less. In such an environment, investment in real assets with a view to inflation protection typically offers hardly any advantages. For the next two years, in our basic scenario we also expect moderate price increases in the Eurozone: 2.5% in 2012 and 1.7% in 2013. Factors in favour of this are the average utilisation of capacity and moderate wage increases. -10 -60 1990 1993 1996 1999 2002 2005 2008 2011 Assets (r.) In/outflows (l.) Source: BVI Diversificationand inflation protection most important 10 In your view, what are the reasons for using real assets? (%) Diversification Inflation protection Risk reduction Increased returns Nevertheless, in the current environment inflation is an important topic for many investors. In the last few months, the ECB has made a great deal of liquidity available to market participants through various vehicles – most recently by two 3-year refinancing options. At the moment, however, this liquidity is not finding its way into the real economy and therefore is not leading to commodity price inflation. A few investors are however concerned that this could take place in the medium term, e.g. as a result of increased inflationary expectations. There is also the risk of so-called asset price inflation, i.e. increasing prices for individual investment classes. Investment in real assets is a logical conclusion for investors who expect inflation rates to increase in the future. Empirical investigations confirm that investment in real assets can be a good choice in phases of high inflation rates. In a long-term observation from 1959 to 2007, Gorton and Rouwenhorst show that the yield on commodity futures has a positive correlation with the inflation rate. The longer the investment period, the greater is the correlation. In other words: In contrast to equities or bonds, investments in commodity futures offer effective protection against inflation.2 As the authors show, this is particularly valid for phases of unexpected inflation. Hedging against undesirable market trends 0 20 40 60 80 100 Agree Partly agree Institutional clients were surveyed Source: Steinbeis Studie, 2010 Inflation at a moderate level 11 Consumer prices, % yoy 8 6 4 Crisis resistance In the last few years, the financial markets have been characterised by crises that have led to increased volatility (see Fig. 12). In view of this market turbulence, for numerous investors preservation of capital has become an important objective. To many investors, physical gold is the epitome of insurance against geopolitical and economic risks, as well as those emanating from the financial system. The historically high gold price impressively reflects this. However, many people are also reassured by real estate – in particular a private home of their own – which is regarded as “concrete gold”. However, by no means all real assets can be categorised as traditional “safe havens”. Instead, it is essential to analyse whether, and to what extent, the prices of real assets and their current yields (if any) could be affected by shocks or could react to economic trends (see the next section on diversification). Diversification 2 0 -2 90 94 98 02 06 10 US UK DE The increasing global networking of the commodity and financial markets has resulted in the economic cycles in Europe and the USA running in parallel for many years (see Fig. 13). There is also considerable correlation of stock market trends. Shocks, such as the collapse of the US bank Lehman Bros., have been IT Source: OECD JP ES 2 See: Gorton, Gary and K. Geert Rouwenhorst (2005). Facts and fantasies about commodity futures. Yale ICR Working Paper No. 04-20. Investors must take into account that, for real asset investments with regular incomes, the latter also have to rise in line with inflation in order to avoid devaluation of the receipts in real terms over the term of the capital commitment (e.g. indexation of rents). 4 | June 6, 2012 Current Issues Real assets: A sought-after investment class in times of crisis High volatility at times 12 Index (l.), % (r.) 9,000 80 8,000 70 7,000 60 6,000 5,000 4,000 3,000 2,000 20 1,000 10 0 0 06 07 08 09 10 11 12 DAX (l.) VDAX (implicit volatility, r.) felt worldwide. Investors therefore integrate real assets in a portfolio because they have a low correlation with the yields on equities and bonds. This connection can be shown empirically, e.g. for commodities.3 Gorton and Rouwenhorst show that the yields on commodities futures have a negative correlation with the yields on long-dated bonds and – for long holding periods – with equities. Commodities futures could therefore be employed effectively in order to diversify equity and bond portfolios.4 On the other hand, according to Yee’s analysis, high correlation coefficients are evident in a comparison of the yields on financial assets with those of metal or energy producers or with REITs.5 The connection with the stock market therefore predominates in this case. Investments in real assets by means of stock in raw-material producing firms therefore do not contribute to diversification of the portfolio. The selection of the investment vehicle is therefore a decisive factor for real asset investments in order to minimise portfolio risks. Source: Bloomberg ... - tailieumienphi.vn