Asia Infrastructure

Lower Volatility, Lower Correlation

27 May, 2020

Delivering Lower Volatility

Asia Pacific Real Assets have proven over the long term that it is not as volatile as regional equities. During a period of high volatility, asset classes which are mostly dependent on earnings and economic cycles will fluctuate greatly. However, listed infrastructure that are underpinned by ownership of tangible, physical properties, resources, and regulated contracts which will most likely not experience the full extent of a risk induced sell-off. Over the last one, three and five years, an equally weighted index of Asia Pacific ex Japan real assets consistently displayed lower volatility than regional equities (Chart 1)

CHART 1: Asia Pacific ex Japan Real Assets’ volatility vs Regional Equity Indices. Annualized volatility across over the last 1,3, 5 years (31 March 2020)

Source: Bloomberg, as of 31 March 2020. Asia Pacific ex Japan Real Assets refers to an equally weighted volatility of 1) FTSE EPRA/NAREIT Asia ex Japan REITs Index, MSCI AC AP Excluding Japan Utilities Index, MSCI AC Asia ex Japan Infrastructure Index. Asia Pacific ex JP Equity refers to the MSCI AC Asia Pacific Excluding Japan Index. World Equity refers to MSCI World Index; US Equity refers to S&P 500 Index;

Providing Lower Correlation

Asset allocators are always on the lookout for assets that diversify sources of risk and reward, with correlation a key evaluation metric. Real Assets have a history of having low correlations with equities and bonds for a variety of reasons.

Firstly, the underlying Real Assets that listed REITs, utilities and infrastructure hold cannot simply be bought and sold on a secondary market, hence these tangible assets are not at the mercy of short-term traders. Another reason for the lower volatility is the idiosyncratic nature of the underlying investment. For example, a 100% tenanted rent collecting mall, may not be directly and immediately susceptible to a sudden one day 10% drop of the S&P 500 Index. Draw down risks, in this instance, are dramatically reduced. 

CHART 2: Asia Pacific ex Japan Real Assets’ correlation vs. Global Asset Classes. 3 Year correlation (29 Feb 2020)

Source: Bloomberg, as of 29 February 2020. REITs: FTSE EPRA/NAREIT Asia ex Japan REITs Index; Utilities: MSCI AC AP Excluding Japan Utilities Index; Infrastructure: MSCI AC Asia Pacific Infrastructure Price Return USD; Asia Pacific ex JP Equity: MSCI AC Asia Pacific Excluding Japan Index; Europe Equity: MSCI Europe Index; US Equity: S&P 500 Index; World Equity: MSCI World Index; Global Bond: Bloomberg Barclays Global-Aggregate Total Return Index; Global High Yield: Bloomberg Barclays Global High Yield Total Return Index.

The Bottom Line

Over the last decade, cheap money from central banks  has resulted in heightened correlation between equities and bonds, which traditionally were meant to offset each other in an asset allocation framework Going forward, it is not inconceivable that both equities and bonds could weaken in tandem when sentiment worsens during a global financial crisis. Hence, the need to seek lower volatility and decrease overall portfolio correlation is even more appropriate today. 

Source: Legg Mason and Martin Currie. Data as at 31 March 2020 unless otherwise stated.

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