Video - September 24The Opportunity in Real Assets
Transcript
Christian Kansler:
Hi, I'm Christian Kansler, Director of Sales for the Cromwell Funds. Today, I'm joined by Eric Rothman, Portfolio Manager at CenterSquare Investment Management, Sub-Advisor of our Cromwell CenterSquare Real Estate Fund, and also joined by Eric Bright, Portfolio Manager at the London-based Foresight Group, Sub-Advisor of our Cromwell Foresight Global Sustainable Infrastructure Fund.
Real assets were negatively impacted as a result of the Fed's aggressive rate hikes over the past few years. But with rate cuts finally upon us, real assets potentially stand to benefit.
Eric Rothman, let's start with you. Now we've seen real estate rise significantly over the past year alone. So what is the case for REITs in the new rate environment? And have investors missed the run up?
Eric Rothman:
There has been a massive gap in the performance between the REIT space and the S&P 500 since year end 2021. That's directly a result of the change in monetary policy back then.
In fact, September 20th, through December 31, 2021, there's been a 30 percentage point gap between the performance of REITs and the S&P 500. That leaves a whole lot of ground to reclaim. From an earnings and valuation standpoint, REITs for a lot of different reasons tend to trade at 2 to 3 turns higher on a forward multiple basis than the S&P 500. Today, you're actually buying REITs at a more than a one times lower multiple than the S&P 500.
Lower interest rates benefit the REIT market in a lot of different ways. Maybe the most obvious is in terms of that residual value. Lower required return makes for a higher ending value.
REIT dividend yields are a little bit more competitive today even than they had been refinancing headwinds actually become a little bit less in the new environment. But most important—the changes in, and dramatically so, the sentiment around the REIT space and sentiment too often doesn't get the credit that it deserves in terms of it being a very powerful mover of the capital markets.
Christian Kansler:
And Eric Bright over to you. Renewable infrastructure was especially hard hit with rising rates. What is the case for infrastructure in the new rate environment?
Eric Bright:
As we move forward into a world where rates are expected to fall, our fairly prudent assumption is they do fall but stay only moderately higher than they have been in the recent past. That is a very positive environment for infrastructure stocks.
We think about infrastructure businesses. We think about the sort of investment returns that they can generate as being subject to, firstly, the cost of capital and then secondly, the return on investment capital that they can generate from new projects.
Secondly, we've seen share price impact from higher rates on listed real infrastructure. Some of this is very much rational—a higher risk-free rate warrants a lower share price—but in practice, we believe that that's gone too far. And so our companies offer deep discounts to our interpretation of fair value.
And I think finally, we continue to believe that infrastructure is a sector that you can go to for very high-quality and very defensive earnings. And in a world where we are potentially going to navigate some fairly tricky economic conditions, that could be a value that is recognized by investors.
Christian Kansler:
Eric Rothman back over to you. We saw REITs trading at substantial discounts to NAV as a whole over the past couple years. That's compressed a bit recently with some of that strong performance. Is there a valuation opportunity for those higher quality class A properties that you're focusing on?
Eric Rothman:
With REITs trading roughly in line with current estimates of net asset value, by the way, before you assume potential for interest rates to come down and net asset values to rise, REITs really find themselves in the sweet spot today.
They're set up in a Goldilocks type of scenario in terms of their ability to buy good assets from other owners in the private market who may have a bad balance sheet and are not in the same strength of position as the REITs. And so the REITs should be able to grow accretively, ignite some new external growth to result in higher earnings growth.
We're at this moment where it could really kick off and ignite that virtuous cycle of rising earnings growth to lead to higher performance.
Christian Kansler:
Thank you, Eric. And Eric Bright, same question for you as it pertains to the three infrastructure categories or buckets that you invest in. What is the current valuation opportunity?
Eric Bright:
We invest into three fairly broad areas within the infrastructure market: renewable energy, digital infrastructure and core and social infrastructure. We can compare valuations in listed markets to those in private markets. And hence we can take a view on what is the prevailing valuation opportunity across public or private.
I think a further piece of that puzzle that we can look at is what are our companies selling parts of their own portfolio at? And how does that compare to the trading share price? What we've observed as well as the rate cut narrative has picked up, we've seen a pickup in transactional activity. More and more institutional capital is coming to the market and shopping around for these assets. And what we believe is that there's a pretty clear valuation opportunity in public markets.
Public market companies are trading below transaction values. We've seen a pretty notable pickup in deal volume in the renewable energy sector this year. That has included a focus on renewable energy business that have a pipeline for future growth.
Christian Kansler:
Great. Well, gentlemen, thank you very much. Some great information was shared today. For more information on the funds, please visit our website or you can call our Advisor line. Thanks again and take care.
Christian Kansler:
Hi, I'm Christian Kansler, Director of Sales for the Cromwell Funds. Today, I'm joined by Eric Rothman, Portfolio Manager at CenterSquare Investment Management, Sub-Advisor of our Cromwell CenterSquare Real Estate Fund, and also joined by Eric Bright, Portfolio Manager at the London-based Foresight Group, Sub-Advisor of our Cromwell Foresight Global Sustainable Infrastructure Fund.
Real assets were negatively impacted as a result of the Fed's aggressive rate hikes over the past few years. But with rate cuts finally upon us, real assets potentially stand to benefit.
Eric Rothman, let's start with you. Now we've seen real estate rise significantly over the past year alone. So what is the case for REITs in the new rate environment? And have investors missed the run up?
Eric Rothman:
There has been a massive gap in the performance between the REIT space and the S&P 500 since year end 2021. That's directly a result of the change in monetary policy back then.
In fact, September 20th, through December 31, 2021, there's been a 30 percentage point gap between the performance of REITs and the S&P 500. That leaves a whole lot of ground to reclaim. From an earnings and valuation standpoint, REITs for a lot of different reasons tend to trade at 2 to 3 turns higher on a forward multiple basis than the S&P 500. Today, you're actually buying REITs at a more than a one times lower multiple than the S&P 500.
Lower interest rates benefit the REIT market in a lot of different ways. Maybe the most obvious is in terms of that residual value. Lower required return makes for a higher ending value.
REIT dividend yields are a little bit more competitive today even than they had been refinancing headwinds actually become a little bit less in the new environment. But most important—the changes in, and dramatically so, the sentiment around the REIT space and sentiment too often doesn't get the credit that it deserves in terms of it being a very powerful mover of the capital markets.
Christian Kansler:
And Eric Bright over to you. Renewable infrastructure was especially hard hit with rising rates. What is the case for infrastructure in the new rate environment?
Eric Bright:
As we move forward into a world where rates are expected to fall, our fairly prudent assumption is they do fall but stay only moderately higher than they have been in the recent past. That is a very positive environment for infrastructure stocks.
We think about infrastructure businesses. We think about the sort of investment returns that they can generate as being subject to, firstly, the cost of capital and then secondly, the return on investment capital that they can generate from new projects.
Secondly, we've seen share price impact from higher rates on listed real infrastructure. Some of this is very much rational—a higher risk-free rate warrants a lower share price—but in practice, we believe that that's gone too far. And so our companies offer deep discounts to our interpretation of fair value.
And I think finally, we continue to believe that infrastructure is a sector that you can go to for very high-quality and very defensive earnings. And in a world where we are potentially going to navigate some fairly tricky economic conditions, that could be a value that is recognized by investors.
Christian Kansler:
Eric Rothman back over to you. We saw REITs trading at substantial discounts to NAV as a whole over the past couple years. That's compressed a bit recently with some of that strong performance. Is there a valuation opportunity for those higher quality class A properties that you're focusing on?
Eric Rothman:
With REITs trading roughly in line with current estimates of net asset value, by the way, before you assume potential for interest rates to come down and net asset values to rise, REITs really find themselves in the sweet spot today.
They're set up in a Goldilocks type of scenario in terms of their ability to buy good assets from other owners in the private market who may have a bad balance sheet and are not in the same strength of position as the REITs. And so the REITs should be able to grow accretively, ignite some new external growth to result in higher earnings growth.
We're at this moment where it could really kick off and ignite that virtuous cycle of rising earnings growth to lead to higher performance.
Christian Kansler:
Thank you, Eric. And Eric Bright, same question for you as it pertains to the three infrastructure categories or buckets that you invest in. What is the current valuation opportunity?
Eric Bright:
We invest into three fairly broad areas within the infrastructure market: renewable energy, digital infrastructure and core and social infrastructure. We can compare valuations in listed markets to those in private markets. And hence we can take a view on what is the prevailing valuation opportunity across public or private.
I think a further piece of that puzzle that we can look at is what are our companies selling parts of their own portfolio at? And how does that compare to the trading share price? What we've observed as well as the rate cut narrative has picked up, we've seen a pickup in transactional activity. More and more institutional capital is coming to the market and shopping around for these assets. And what we believe is that there's a pretty clear valuation opportunity in public markets.
Public market companies are trading below transaction values. We've seen a pretty notable pickup in deal volume in the renewable energy sector this year. That has included a focus on renewable energy business that have a pipeline for future growth.
Christian Kansler:
Great. Well, gentlemen, thank you very much. Some great information was shared today. For more information on the funds, please visit our website or you can call our Advisor line. Thanks again and take care.
Past performance is not a guarantee of future results. Price to adjusted funds from operations (P/AFFO) is used to evaluate the relative value of REITs. AFFO measures a REIT’s funds from operations with adjustments made for recurring capital expenditures used to maintain the quality of the REIT’s underlying assets.