In our Outlook last year, we said, “We believe inflation will likely begin falling later in 2022.” And though that turned out to be true, we came to that conclusion because we believed the Fed would choke off the pressures of inflation. Coming into 2023, it appeared as though inflation would continue to retreat lower, but unexpected price increases have complicated the picture. There are now banking instability issues, geopolitics, a softening economy, and a dozen other headline issues weighing on investors’ minds.
We believe the Fed will keep policy tight until inflation returns to their target level. We do not want to be on the other side of that trade. We expect rates to stay higher for longer, which could present challenges and opportunities across private markets which have broadly failed to adjust equity values for the new higher-rate environment.
The Verus 2023 Real Assets Outlook includes insights around the following trends:
- Dislocations in Commercial Real Estate: The multi-decade decline in interest rates that have provided a tailwind in real estate reversed in mid-2022. Private real estate cap rates have not kept pace with the move to higher rates recently, reflecting a reluctance to mark assets to the new rate regime. Over the near term, we expect rising cap rates, slower growth, and higher borrowing costs to continue to pressure private real estate valuations and likely trigger pockets of stress and distress.
- Elevated valuations in Infrastructure: In a year when inflation and rising interest rates depressed equity and debt valuations, slowed transaction activity, and disrupted capital markets, real assets (excl. real estate) performed remarkably well. The issue we see today is that valuations are stretched, and debt costs are increasing, but equity valuations have yet to adjust to a higher interest-rate environment.
- Declining interest in Natural Resources: Commodity-related investments experienced a marked rebound in performance in 2021 and 2022, following years of disappointing performance. Oil and gas companies rode high as they outperformed every other sector in the equity universe. And yet, despite this renewed attention, the fundraising environment for natural-resource funds remains bleak.