Property and infrastructure

We are interested in property and infrastructure (below, for illustration purposes).

Headlines

TLDR (too long, didn’t read). The banking crisis seems to be settling down. Some asset classes have really suffered over the past month. Monetary policy potentially nearing end of tightening cycle. Modest initial exposures, getting slightly larger.

Property

The asset class is off some 25%, depending on the region, depending on the manager, and any time an entire asset class sells off by a full quarter we are going to get interested.

Our property exposures, at the portfolio level, are very modest. A 5% weighting, for example, going to 6% isn’t going to break the portfolio if you have miscalculated.

But, it still makes sense to apply the “didn’t you know” filter, in which I picture a hypothetical interlocutor mocking the trade (in a kind way, it’s just illustrative, because DAA trades are all about expectations). By definition, any trade away from benchmark is you arguing with the market, whether you know it or not.

In that vein:

Didn’t you know rates have gone up, and that property gets crunched in higher rate environments.

Yep, that’s why the sector is off a lot. I do think, on net, the long run equilibrium interest rate is quite a lot lower, than the current rate, and that’s mildly helpful, at the margin. If you thought that rates will just keep going up, it wouldn’t be a great idea, if that was your only factor in/under consideration.

Didn’t you know Office is collapsing, and NTA’s are wildly overstated.

Another version of this:

Didn’t you know WFH is here to stay.

Well, I agree. There will be some office footprint still in demand, since hybrid working (say 3 days in the office) will mean some office space is required, even if it is less overall. And absolutely, some office write-downs are/will come, potentially by more than 20%. That will absolutely be a stress event for the sector.

But the office sector, in the Vanguard International benchmark, to pick a widely used benchmark (purple, below) just isn’t that huge. There’s plenty of other sectors. So, the office consideration is absolutely relevant, but it isn’t everything, and there are good reasons to think that high quality office space (prime, premium grade) that encourages collaboration and culture, will do okay.

There’s also some hope (and hope is all it is) that perhaps some of the surplus office space can be repurposed (e.g. converted to apartments, but this is very difficult, and doesn’t happen much) and also perhaps (an even longer bow to draw) that smaller, 3-4 story tall suburban office parks get repurposed (where it is much easier to redevelop, given space, and size) and as that supply exits the markets, existing tenants might move “one rung up” in terms of quality, if the rents are in the right range, meaning some net absorption could occur that way. But it’s kind of scratchy reasoning. Not silly, but not airtight.

Let’s recap. Asset class off 25%, might fall further, our tiny position expanded at the margin in the expectation/hope/detailed-forecast that perhaps the sky doesn’t fall.

If the sky does fall, and we have a 1980’s CRE wipe-out, well, maybe we’ll buy another percent at that time.

Back to the didn’t you know frame. To make some alpha, which is what DAA is trying to do, you’ve got to disagree with the market, and here, the market has some powerful arguments to shout at you, which are all very reasonable points. That said, the alpha opportunities are usually the best when it looks completely idiotic to disagree, i.e., when fear and news-flow is maximally negative.

None of that guarantees the trade works out, but by keeping the tilt small, the risk and rewards seem justified.

Infrastructure

Infrastructure has had a less acute drawdown, but has still been under pressure, given infrastructure is typically long duration, in the same way as property.

The graph below looks at a bunch of Alts’ managers, let your eye be drawn to the infrastructure names, where, whilst perhaps a little hard to read, you should at the least be able to see some of the metrics like Price/Sales, Price/Book, Price/Earnings all trending notably lower, as infrastructure has drawn down.

However, infrastructure does have inflation pass-throughs, which can occur at a bit of a lag, as regulatory approval for WACC + X resets roll-through. Passing on higher prices to end consumers is obviously helpful, and, longer run, we have tailwinds from capital expenditure programs associated with climate change and the need to “electrify everything”.

That capex will drive the regulated asset base (RAB) on which infrastructure companies set revenues, which flows through to cashflows and earnings, in particular, for the regulated electric utilities.

So we think it a reasonable story, in a sector that (usually) has reasonably defensive, predictable earnings. The look through PE’s of managers like RARE are quite modest, at around 18-20x (modest for infrastructure) and so, in a similar vein to our commentary above on property, a small incremental addition appears reasonable.