One real asset class that comes to mind for many who want an edge against inflation is infrastructure, especially utilities. But that’s a mistake, says David Sekera, chief US market strategist at Morningstar. In fact, “utilities are one of the hardest hit areas if inflation persists,” he says, “over the past 30 years, when inflation rose over 3%, yields at term over 2 years were negative.”
Primarily due to their cumbersome regulatory environment, “utilities have no pricing power,” Sekera continues, “they have fixed revenue streams but variable costs and they have a 6-18 month lag before to be able to recoup their costs. They have huge infrastructure costs that can take a long time before they can be passed on to consumers.”
Rental prices lead the way
REITs are where hopes of staying ahead of inflation can come to fruition. “They can generally keep up with inflation,” says Sekera, “but stick to sub-sectors that benefit from short-term leases, like apartments, retirement homes, hotels even more. , stay away from niche areas like cell towers or triple net rental structures.They are locked in with long term leases and even though they have inflation escalation clauses these are often capped or simply not adequate for the kind of inflation we have had recently.
Indeed, our current inflation has been accompanied by sharp spikes, says Eric Menzer, lead portfolio manager of the Manulife Real Assets Fund. “Much of the real estate market cannot adjust rents quickly enough,” he notes, “it all depends on the length of leases and their position relative to the market.”
There is one aspect that investors should be aware of, warns Menzer: “As inflation rises and growth slows, there could be a correction in house prices.”
Menzer’s fund is one of the few funds that gives investors direct access to real assets rather than stocks. Tellingly, the original institutional version of the fund was up 8.59% as of June 24, ahead of this summer’s rally, Menzer reports. A key feature of his fund is its low correlation of around 0.45 to equity and bond markets, while performance, he says, is driven by exposure to agriculture and commodities.
However, agricultural assets and products should be approached with caution. Agribusiness “doesn’t move at the same pace as any other economic sector,” stresses Seth Goldstein, equity strategist with Morningstar’s Energy and Resources team, “agricultural assets are not bad hedges against inflation, but not the best either. .”
On the agricultural front, a factor like inflation will have little influence on prices if a key region like South Africa experiences a bumper harvest or if Ukraine suffers a supply shock, such as the current case. Basically, Menzer points out, “weather and supply/demand are what drive prices.”
Mineral and energy commodities can also offer inflation protection, “but it depends on the valuation of each specific commodity and when you bought it,” Sekera warns. For example, lumber is a commodity that Menzer’s fund specializes in, and one that has shown tremendous price growth since the pandemic, but “we’ve seen lumber inflation long before the current price hike. consumer price index,” Menzer notes.
Among mining assets, lithium is currently showing explosive growth that has little to do with inflation. “Demand far exceeds supply every year, Goldstein explains, and this has resulted in record prices of $70,000/tonne last year, compared to mid-2020 at $7,000. We believe demand will continue to grow by 20%, which will see it grow fivefold by 2030, and supply will consistently lag.” The main drivers here are battery storage and electric vehicles. Lithium “is one of the best ways to play long-term secular growth in electric vehicles,” says Sekera.
But is lithium in itself a hedge against inflation? Yes, Goldstein replies: “In a normal market it would be, and in the same way as other commodities. If supply and demand were balanced, growth would move in line with inflation.