Investing in physical assets

Slow-and-steady returns for patient investors

After a period of low-interest rates, coupled with the printing of money in the world’s largest economies (such as the US and UK), monetary policy is getting tighter.

This means that interest rates are rising and that it is harder to get low-interest-rate loans.

In addition, investors seek a higher return than they can achieve when investing in the money market, as inflation across the world eats away at real returns.  This trend has prompted a shift in approach where ‘boring’ investments with relatively predictable returns are getting to be in vogue again.

These investments include value stocks (such as those selling necessities like food, toiletries, and fuel), and those assets whose returns are linked to inflation—especially infrastructure-related assets.

In many large European countries, for example, the private sector has been a key investor in infrastructure such as electricity generation, toll roads, ports, electricity generation plants and railway operators.

For South Africans, this is a relatively new market with lots of opportunities.  However, following the liberalisation of the electricity generation market in July 2022, the government has realised that the private sector can play an important role in addressing the nation’s power generation shortfall.  The government actions that made this possible, include the following:

In July 2022, National Treasury set the maximum allocation by retirement funds to infrastructure at 45%.  Treasury also broadened the definition of what infrastructure entails when it amended Regulation 28 of the Pension Funds Act.

Also in July 2022, the government dropped the 100MW installed capacity limit for private companies that want to generate their own electricity.  This action has drawn considerable interest from SA’s larger banks to fund large companies’ electricity generation projects.

In February 2023, Finance Minister Enoch Godongwana announced in his Budget speech** that with effect from 1 March 2023, businesses would be able to claim a 125% tax deduction in the first year for renewable energy projects, while individuals can now claim 25% of the cost of new solar PV panels installed at a private residence.

In April 2022, the government also said that it would allow private rail operators onto SA’s busiest rail corridor, between Johannesburg and Durban, for an initial period of two years.

Although this time frame of two years has been criticised as it will make it extremely difficult for the potential operators to recoup their capital investment in such a short time, some of the larger banks have indicated that they are in talks with the government to liberalise this sector in the same way as electricity generation.

Types of real assets available to SA investors:

There are several types of real assets from which investors can choose.

–  Real estate investments: These assets can include land and buildings for commercial, industrial, retail, agricultural, and/or residential purposes.

– Renewable electricity: These assets can include solar photovoltaic (PV) and concentrated solar power, hydroelectricity, wind, and biomass energy plants.  These plants have offtake agreements with the electricity distributors which extend over multiple years, ensuring a reliable income stream.

– Precious metals & commodities: These assets can include iron ore, coal, gold, maize, coffee, sugar, etc.

– Infrastructure assets: These assets can include roads, railways, airports, ports, dams, etc.

Benefits of investing in real assets:

Real assets (including real estate and infrastructure) take time to construct and require a significant amount of money, management time, and experience.

To recoup the capital invested in an asset, offtake agreements—in the case of infrastructure—are concluded with a government entity for a long period, typically more than 15 years.  This means that such assets tend to provide a predictable stream of income, with increases usually indexed (linked) to inflation.

How to invest in real assets:

There are various products available to investors and retirement funds that wish to invest in real assets.

Real estate investment trusts (REITs):

Arguably the easiest way to invest in a real asset is through South Africa’s well-regulated and listed REITs.  These trusts hold portfolios of property in the retail, hospitality, office, industrial and (more recently) residential sectors.  Various unit trusts and exchange-traded funds in turn hold portfolios of REITs.

The expected dividend yield on a REIT is in the order of the prevailing inflation rate.

Infrastructure equity and debt funds:

Some private equity and debt funds invest directly in underlying infrastructure assets, such as electricity generation plants.

These funds are not listed and usually have a minimum investment amount with a lock-in period during which investors cannot withdraw their investment.

The reason for this is that the shares of the underlying infrastructure assets are not easily traded (illiquid).

Listed infrastructure assets:

In South Africa, there is a dearth of listed infrastructure stocks on the country’s stock exchanges.  With so few companies and funds that are solely invested in infrastructure assets, most of them are very illiquid due to the high demand for this asset class.

Alternative real assets:

Krugerrands, rare coins, art, and other collectables are some examples.  However, these assets (by their very nature) are not income-producing, and their returns, therefore, come in the form of capital appreciation.

While Krugerrands are linked directly to the gold price, markets for other alternative real assets tend to be quite niche, values tend to be based on what is considered desirable at a point in time, and specialist knowledge is often required.

Exchange-traded funds (ETFs):

Buying shares of ETFs that specialise in real assets, such as commodities, property, or infrastructure for example.  Since ETFs are traded on recognised exchanges and provide diversification within the asset class, liquidity tends to be better than for individual stocks.

Glossary

Value stocks: A value stock refers to shares of a company that appears to trade at a lower price relative to its fundamentals, such as dividends, earnings, or sales, making it appealing to investors.

Infrastructure: According to the amended Regulation 28 definition, infrastructure refers to “any asset that has or operates with a primary objective of developing, constructing and/or maintaining physical assets and technology structures and systems for the provision of utilities, services or facilities for the economy, businesses, or the public.”

REIT: REITs, or real estate investment trusts, are companies that own or finance income-producing real estate across a range of property sectors.

WRITTEN BY Atleha-Edu (updated by STEVEN JONES)

The original article was published by Atleha-Edu.  Updated material was added by the Editor following this year’s Budget speech which took place on 22 February 2022.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE).