Investment Outlook 2024: Real Assets Debt

Demographics, decarbonisation, and deglobalisation are pro-inflationary, these “3D” trends will impact the economic environment through higher ‘normal’ levels of inflation, and interest rates.

These trends have created a fantastic environment for debt investors. We see a broad opportunity set for coupon hunters allowing for debt opportunities alongside the evolution of the economic conditions.

Probably the most visible example of evolution will be seen in the commercial real estate sector. There is such a huge range of potential for opportunity as the cycle here evolves, particularly given some of the fundamental changes to debt provision but given the key changes in supply-demand dynamics globally in sectors like residential property (low supply relative to demand) and office property (high supply relative to demand). There will be different types of opportunities in different regions, driven by these changes, on which investors can capitalise.

Real estate debt: Opportunity to address funding gaps, and opportunity created by fundamental change.

In the US banks and the commercial mortgage-backed securities (CMBS) market typically provide about two thirds of financing for commercial real estate. What we are seeing today is unprecedented, because both lenders are pulling back at the same time. This will create opportunities to provide financing on fundamentally sound properties where lenders, such as regional banks and banks, have pulled back. Likewise, a funding gap for real estate is also substantial in Europe.

There will also be a need for opportunistic lending in areas where headlines are prevalent, for example office properties where there is an ongoing structural reduction in demand combined with record amounts of supply coming online.

Debt investors can take advantage of both types of opportunity in commercial real estate debt. In both the US and European markets there is an opportunity to step into the capital gap where traditional lenders are pulling back. For alternative lenders that understand the sector-specific risks, bridging this funding gap cap be very rewarding.

Infrastructure debt: The defensive debt opportunity, offering inflation protection.

Opportunities in the infrastructure market are different. The funding gap is not a key dynamic. Demand for private capital in infrastructure debt has steadily supported by megatrends such as energy transition and digitisation; huge themes that require substantial investment capital.

The infrastructure debt asset class fares very well in a pro-inflationary economic environment due to its natural hedge against inflation. As well, it is low in volatility, spreads have remained stable for years, even while interest rates and total return, have increased over the past two years. We believe risk adjusted returns for infrastructure today are as attractive as they’ve ever been.

Emerging market infrastructure debt offers a set of dynamics driven additionally by a substantial capital shortfall. There is a significant funding shortfall versus the UN’s Sustainable Development Goals (SDGs). There was a considerable gap, a lack of investment that should have happened over the last few years, so the need for infrastructure financing has only grown in the emerging markets. The magnitude is huge, it is multiple trillions of dollars that are required. Emerging market infrastructure debt opportunities can provide stable yield, with a hedge against inflation, with the added benefit of potential for positive impact, and these are typically projects with USD revenue streams, avoiding costly currency hedges for investors.

Across real assets, there are scalable opportunities, actionable today, that offer diversification, low volatility, and multi-decade, high levels of income. At a point where expected income-oriented returns are much closer to those returns expect from the asset itself, we believe embracing the protection and income that debt can offer is an important component to evolving a portfolio allocation alongside the evolution of the global economy.