A Place (and Case) for Real Assets in Portfolios
Author: Steve Bonnyman
June 19, 2023
As global central banks have attempted to temper re-emergent inflation, we may be witnessing the end of a roughly 40-year cycle of broadly lower interest rates and the establishment of a new investment environment with persistently higher interest rates than we’d become accustomed to the past 15 years. Over the past two years, many global bond and equity valuations have declined, apparently diminishing the traditional diversification benefits of a stock/bond portfolio. This rising correlation between the two asset classes puts a renewed focus on the need for portfolio diversification – and, potentially, the introduction of less correlated assets into a balanced portfolio.
With that in mind, real assets strategies – which invest in tangible assets such as commodities, real estate and infrastructure – may offer an attractive opportunity for investors. Here below, we discuss the potential benefits of a broadly diversified real assets allocation and some of the key themes that may help determine their investment performance in the future.
Potential Benefits (and Risks)
A core allocation to alternative strategies such as real assets is susceptible to losses like any type of investment and their performance — for better or worse — depends on several factors including the economic cycle, monetary policy, geopolitics and corporate earnings. Still, when conditions are right, real asset strategies may improve the risk/reward profile of a portfolio and in many cases they have historically enhanced exposure to traditional assets by providing diversification, increasing yield and mitigating the risk of inflation in the portfolio.
An investor can achieve exposure to real assets in several ways: Direct ownership that involves purchasing and managing the asset directly, such as buying a rental property or investing in farmland; allocating capital to individual companies that own real assets; allocations; investing in sector-specific strategies (i.e. a basket of real estate investment trusts); and broadly diversified real asset strategies that may offer exposure to all or a sub set of the above.
In our view, an actively managed, broadly diversified real asset strategy has several advantages over the other options:
- A broadly diversified strategy often rebalances among the various assets classes it invests in to maximize the risk/reward profile.
- Unlike a sector-focused strategy, a broad real assets strategy has a higher likelihood of diversification among sectors, which reduces raising the potential for concentrated investments in a few focused sectors.
- A broadly diversified strategy may allow investors to focus more on their portfolio core rather than on the idiosyncratic risks of smaller (real asset) sectors.
Beyond these advantages, it’s also important to note that real assets remain a critical component of several major investment themes in the market today.
- Inflation: Real assets, in particular commodities and real estate, have traditionally provided some of the best inflation protection available in the market.
- Artificial intelligence: All the servers supporting growth in AI will be housed in data centres, a growing component of the infrastructure universe.
- Green energy: Utilities dominate the development of renewable energy and stand to benefit from the evolving green transition.
- Decarbonization: Electrification of motor vehicles and other sectors will depend on copper and other metals for cables, batteries and other key elements of electricity generation, storage and transport. There will also need to be a major infrastructure buildout to support the electrification of the modern economy.
- The hydrogen economy: Utilities will produce hydrogen, pipelines will move it, and industrial gas companies will manage it.
- Re-Shoring: The repatriation of manufacturing from Asia will require construction of new production facilities, supporting demand for cement and other building products.
While each of the core components of real assets provides some degree of diversification or yield, the power of the group lies in managing the balance of the group and the idiosyncratic risk that each entail.
The upshot? Real assets have the potential to provide income, diversification and protection from inflation – a compelling case for why these strategies may have a place in a balanced and managed portfolio.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
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