LONDON: Investors’ interest in physical assets such as real estate and infrastructure is surging. In a low-yield world, the yearning for higher returns is understandable. But the conditions are also in place for over-enthusiasm to lead to a mispricing of risk.

Six in 10 senior investment professionals plan to raise allocations to real assets, a BlackRock survey recently showed.

Norway’s central bank, which manages the country’s wealth fund — the largest in the world — said in February the institution should reduce its fixed income portfolio in favour of real assets. And Allianz Group said on Feb 26 it was raising its mid-term target for real asset-based financing by a third to 110 billion euros.

Physical assets offer an illiquidity premium which is alluring at a time when bond markets offer such meagre returns. A portfolio of buildings could yield a premium of around 250 basis points over government bonds, UBS Wealth Management research predicts. Premiums are currently up to 50 basis points higher because of depressed government bond yields.

Real assets have other advantages. They typically don’t move in lockstep with financial markets. And for those willing to tie their money up for a while, assets such as real estate and infrastructure can marry predictable cash flows with low volatility.

This is ideal for life insurers and pension funds which have longer investment horizons. Hence the $900 million purchase of the UK government’s 40 per cent holding in Eurostar by a Canadian manager of public pension funds and British asset manager Hermes.

But what happens when a horde of other asset managers muscle in on these relatively small and illiquid markets? Bottlenecks can easily develop, shifting the advantage to sellers.

True, the need for new and upgraded infrastructure in both emerging and developed markets will meet some of the increase in demand. However, government involvement in some infrastructure projects curbs volatility but brings regulatory risk. Infrastructure projects tend to be complicated and technology-dependent. Pricing operational and technical risks is not for novices. A sustained surge in interest could see an underpricing of some of the risks inherent in real assets.

Published in Dawn, March 5th, 2015

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