Private real assets: an insurer’s experience
How and, more importantly, why does the TIAA General Account invests in private real assets? Marc deBree, head of real estate and alternative assets at TIAA, answers this question and discusses the challenges and solutions real assets present in regards to portfolio construction, responsible investing and more.
Why did the General Account begin investing in private real assets?
The General Account (GA) became a consistent equity holder of real estate assets in the 1990s, having been investing in commercial mortgages as far back as the 1930s. As we became more comfortable as a real estate equity investor, we looked for additional equity opportunities in other real assets.
Our first timberland investment was in 1998, driven by portfolio diversification goals, the promise of a good return and the opportunity to develop a business that could attract third-party capital. Our first farmland investment was in 2007, and our first infrastructure investment was the following year. At the end of the first half 2022, equity real assets including real estate were over 7% of the General Account portfolio.
What are the benefits of adding real assets to an institutional portfolio?
We think of three primary features. The first two – income and capital appreciation – drive real asset returns and values. For core U.S. real estate, we expect long-term, unleveraged returns of around 6% to 7%. For non-core real estate, which the GA identifies as higher risk strategies, such as development and some alternative real estate sectors like life sciences, storage and single-family rentals, we expect about 8% to 10%, unleveraged over the long-term. Farmland and timberland offer a similar range of returns.
Infrastructure return expectations are a little higher but vary a lot depending on the type of asset. For U.S.-based core renewable energy assets, returns have been well less that 10%, but for international development infrastructure it can be in the mid-teens in some instances. However, current market conditions are resulting in evolving return expectations with overall return expectations increasing for new investments.
The third benefit is diversification from the lack of correlation that real asset ownership can bring to a large portfolio like the GA. Their low or negative correlations with traditional fixed income investments and their value as a diversified source of income and capital return are very important to us.
What guidance can you give other institutional investors considering allocating to these private real assets?
The capital preservation and inflation-hedging components of real assets along with their ability to diversify your income streams are very real. And in a lot of cases, there are significant tailwinds behind these asset classes – a growing global population that consumes food and timber products, and the move toward a low-carbon economy supporting sustainable practices and renewable energy. These are important investment themes for many institutional investors.
But you really have to appreciate that these are complicated, illiquid investments, with return attributes that are very different from traditional stocks and bonds. Your success is highly dependent on the sophistication and skills of your advisor.
How does the paper's analysis reflect the GA’s thinking about its private real asset exposure?
The research supports our views that adding private real assets to our portfolio improves diversification, provides additional scope for income, and may help reduce overall portfolio volatility. We find this type of mean variance modeling to be useful when considering our allocations to alternatives, allowing us to understand the implications and quantify potential changes.
How do you expect real assets to perform in the current environment of rising rates and inflation?
The cash generation aspects of real assets mean they are a stable source of income, often with revenues that adjust in some way for inflation. Short-term real estate leases, for example, can be marked to market and incorporate rising price levels when renewed. Others with a longer lease profile might have a fixed level of annual increase built in. And while some long-term leases may not reset for inflation, they still provide the benefit of an income stream in a challenging macro environment.
Farmland and timberland contracts are frequently tied to commodity prices. These assets have built-in hedging as they produce components of the basket of goods that make up consumer price indexes.
Inflation-related mechanisms can also be found in some infrastructure contracts, and those assets have the ability to perform well in a recession given their necessity-based nature, such as health services, power and transportation. Of course, it depends on what caused the downturn. Toll roads are usually resilient in a recession but COVID caused an unprecedented decline in road usage and revenues.
The lesson here is to expect pockets of underperformance in a downturn, but have a broadly diversified portfolio to ensure that weaker returns in one area are offset elsewhere. So while some infrastructure assets struggled in the pandemic, farmland and timberland values were stable, helping to preserve capital and avoid loss in the portfolio.
What additional risks do you have with private real assets?
Think about owning a bridge or a power plant. Given how necessary they are to everyday life, if something goes wrong, you need asset managers that are able to resolve operational problems quickly. The critical nature of these services creates reputational risk if managed poorly. You also have legal and structuring risks, counterparty risk and concentration risks that you can more easily avoid or mitigate within a more traditional portfolio.
Partnering with an experienced asset manager makes a difference. They understand these challenges and how to solve for them. A robust and engaged risk team and a risk-oriented culture are important parts of our advisor relationships.
We rely on Nuveen as an advisor, but we also have a cross-functional group of experts at TIAA that provide an extra layer of risk management. It’s a formal, consistent approach to appreciating and assessing the risks inherent in the specific assets which are then tracked as part of the asset’s long-term management.
You also need to be comfortable with the illiquid aspects of private assets. These are long-term holdings that cannot be sold quickly on an exchange. So, having a long-term investment perspective and being able to stay invested through periods of underperformance are both important.
How do you look at real assets from an ESG and responsible investment perspective?
For a long time, the GA has had a responsible investing policy. We apply ESG thinking to our investments across the board. Our real asset investments must fit in with our environmental. Social and governance standards.
From an ESG perspective, especially on sustainability issues, that bar is getting higher each year. Some of our real asset investments go beyond baseline ESG expectations and target specific social and environment returns together with financial returns. Affordable housing is a good example of this.
I’m proud to say TIAA has committed to making the General Account net zero carbon by 2050. Real assets have a role in helping to achieve this, for example, farmland’s lower carbon intensity, timberland’s ability to sequester carbon and the growing opportunities in renewable energy infrastructure.