Tangible assets equity investments have begun to catch up with debt strategies on an absolute return basis as outlooks – particularly for real estate – start to improve, according to the latest ‘Relative value in real assets’ report from Aviva Investors, the global asset management business of Aviva plc.
Despite this, Aviva Investors believes debt strategies still remain compelling, with higher interest rates across markets unlikely to change in the near term and contributing to their continued appeal.
David Hedalen, Head of Real Assets Research at Aviva Investors, said: “Debt markets typically react rapidly to changes in the rate environment, and therefore reprice quickly off the back of market movements. This sits in contrast to real asset equity markets, which can take a bit more time to adjust. But, broadly speaking, the repricing we have seen as a result of market turmoil has largely occurred. Whilst some risks clearly remain, in the absence of further developments, we think markets are beginning to stabilise and offer significant pockets of value.”
Over the past 18 months, real estate has experienced material repricing and volatility, which Aviva Investors expects to subside as markets price at the end of the current interest-rate-hiking cycle. As a result, real estate debt is expected to continue offering considerably greater returns per unit of risk than real estate equity, driven by higher government bond yields and illiquidity premia, whilst also reflecting recent market movements within real estate equity.
Looking across geographies, Aviva Investors views equity investments in the UK as currently screening better than Europe on an absolute basis, despite the weaker growth outlook for the UK. However, it acknowledges that the picture becomes more nuanced when the prevailing risk-free rates between the UK and Europe are also considered.
David Hedalen added: “Repricing for Real Estate in the UK has been rapid, which sits in contrast to Europe. In our view, this puts the UK further ahead on its journey. Within our propriety modelling this quarter, we have seen European returns catch up with the UK, whilst offering lower volatility. In reality, this has merely closed the gap between the two markets, with the UK still offering higher absolute returns compared to the continent.”
Whilst infrastructure equity renewables have remained relatively stable compared to other real assets strategies, Aviva Investors’ modelling suggests increases in expected returns have been partially offset by increased levels of risk over the past six months.
In contrast, the research suggests infrastructure debt remains an attractive proposition, reflecting continued deal flow across the UK and Europe. Despite the competitive landscape, Aviva Investors believes infrastructure debt offers attractive absolute and risk-adjusted returns.
In Real Estate Long Income (RELI), Aviva Investors points to returns having increased in most sectors with a simultaneous reduction in risk across the board. This has primarily been driven by a recalibration of property yields and rental growth expectations, which are often inflation-linked. As a result, Aviva Investors believes RELI’s longer-term outlook has improved in the UK and Europe as yields have adjusted in line with recent interest rate increases.
David Hedalen concluded: “The overall outlook for the sectors we modelled appears to be trending towards a more optimistic picture, particularly as some macroeconomic concerns have begun to abate. We view the prospects for equity markets as having improved, whilst debt continues to offer compelling returns. Considering all of this, we see continued improvement heading into 2024, following what has been a volatile and uncertain 2023.”