A great way for investors to diversify their portfolios beyond the mainstream investments of equities and bonds is to invest in ‘real’ assets.
Real assets are tangible assets that derive their value from their availability to, and usability by, consumers and businesses. They are extremely varied and include, for example, buildings; infrastructure such as toll roads, solar and wind farms; commodities such as energy (oil and gas), industrial and precious metals and agricultural produce, such as wheat and orange juice.
Advantages of real assets
Real assets offer investors several benefits.
Their variety, geographic spread and limited correlation with equities and bonds mean that they can be used to reduce risk through diversification. They can also offer the opportunity to hedge against inflation, secure income from non-traditional sources and generally deliver competitive overall returns.
Although their ‘intrinsic’ values can fluctuate (house prices can go up and down, for example) these do tend to rise over time, providing built-in protection against inflation over the longer term and preserving investors’ spending power.
Commodities such as gold and wheat clearly do not provide income, but other real assets do, such as toll roads and commercial real estate.
Overall, real assets can provide capital growth and income with varying degrees of risk. Commodity prices can fluctuate quite extensively, for example, while the fact that infrastructure assets play a critical role necessary for the functioning of the economy can give them a defensive, lower risk quality, especially during recessions.
Accessibility and liquidity of real assets
Real assets are complex and often require substantial volumes of initial investments.
Investing in commodities, for example, is usually done by professional traders trading large volumes and using specialist instruments such as futures on financial markets, although it is possible to invest in gold and silver on a lower scale for example by buying coins. Other real assets, such as real estate and infrastructure, are illiquid: buying and selling them is usually a long process incurring high transaction fees and requiring expertise.
Real assets can also incur high maintenance costs, for example, which is the case with real estate and infrastructure, while commodities such as precious metals, oil and wheat might involve storage costs.
How can real assets be used in portfolios?
Investing in real assets can be a good diversification strategy because they behave differently from traditional investments and offer a broad range of investment opportunities in terms of asset types and geographies with returns driven by many factors.
Some asset classes are highly correlated in that they perform similarly and react the same way to market conditions. Investing in uncorrelated asset classes helps to smooth investment returns as the possible losses in one class could be softened by gains in another. Historically, real asset investments’ correlation with shares and bonds has shown that they could be used to reduce the long-term overall risk while increasing the potential for growth.
This gives investors a choice of investment themes that they can match to their goals and approaches. For example, a long-term outlook is required to invest in real estate and infrastructure – sometimes decades - whereas short-term trading is possible with commodities.
Investors who want to future-proof their portfolios will find options in real assets, which can offer exposure to new investment themes. For example, as the world transitions from fossil fuels to renewable sources of power then this will create investment opportunities in new types of infrastructure and match many investors’ preferences for sustainable investments, while the increasing use of online shopping is driving a need for logistics facilities.
There are many reasons to believe that real assets will increasingly be recognised as mainstream investments and essential tools for investors to enhance their portfolios, secure attractive risk-adjusted returns and meet their investment goals. However, the high levels of investment and expertise required to invest in real assets mean that for most investors, the best way to invest in them is via managed investment funds, which pool the investments of multiple investors to create diversified portfolios and provide access to the expertise required to select and manage the assets.
Types of real assets
Even though collectively they tend to provide protection against inflation, the term ‘real’ relates to a broad range of asset types that are not necessarily correlated. The main types of real assets include:
Real estate investment
Real estate is a real asset that is readily understood by investors. Owning your own home is the same as holding a residential real estate asset, for example. It is possible to invest in residential real estate, too, by owning a portfolio of properties and renting them out as a landlord. But most of the investment funds by which investors can get exposure to real estate invest in commercial properties such as office blocks, industrial warehouses and shopping centres.
The advantages of real estate investments are that they can offer regular rental income that is often linked to inflation through index-linked leases plus rises in their capital values. Managing and maintaining them requires a lot of time and effort, however, and they are also ‘illiquid’. The economic cycle can be a significant factor in their performance – a lack of occupancy and tenants going bust in recessions seriously damages investment returns, for example.
Infrastructure investment
Infrastructure assets are the physical structures, facilities and networks that enable the economy and society to function. These include, for example, transport facilities such as roads, bridges, ports and railways; communication systems such as telephone networks; buildings such as schools and hospitals; and energy grids and power stations. Power suppliers are of major interest to investors because of the opportunities created by the ongoing transition away from fossil fuel (oil and gas) suppliers to the renewable sources of wind, hydro and solar (photovoltaics) power.
The complexities involved with investing in infrastructure and the necessary resources are similar to those of real estate, only more so: building, identifying, buying, selling and maintaining facilities such as bridges, power stations and dams, for example, involve large sums, detailed contracts and high levels of technical expertise. But they can provide inflation-indexed revenue streams that are resilient in recessions because the end products to which they are linked are usually essential staples, such as energy and transport.
Commodities investment
Commodities are physical goods with the same characteristics as other goods of the same type. Commodities of the same types but from different suppliers should still have little or no variation between them. For example, a barrel of Brent crude oil from one producer should be similar to one supplied by another.
The commodities used for investment purposes are natural resources and raw materials traded on financial markets. These include ‘softs’ (coffee, cocoa, sugar; wheat); oil and gas; base metals (copper, aluminium, tin, zinc, lead and nickel) and precious metals (gold, silver, palladium and platinum).
Trades can be made in commodities using financial instruments known as futures. These are contracts that promise to deliver a set volume and standard of a commodity at a future date. The numbers involved are usually beyond the scope of most individuals though, with one future relating to a lot of 100 barrels, for example.
Actual commodities can also be invested in but this requires physical storage, which again, can be too expensive for most investors if large quantities are involved.
