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Richard Westlund
Allocations to real assets—like real estate, agriculture, timber, energy and infrastructure —can potentially help with many investment goals, while adding valuable diversification to a traditional stock and bond portfolio.
“Investors have been increasing their allocations to this space for some time,” says Stephen Dunn, executive vice president and director of institutional marketing, Cohen & Steers. “But investors need to weigh their objectives and decide what they want to achieve with their real asset allocations.”
Dunn notes that in the past five years the number of listed real asset strategies has increased 55 percent, according to eVestment Alliance, a widely used nonproprietary consultant database.
That wide range of strategies is possible because each real asset class has different characteristics and responds to different market forces. Natural resource equities, for instance, are affected by financial markets, while agriculture and timber values respond to supply and consumption trends.
“In general, real assets are not correlated to the other assets in an investor’s portfolio,” says Jose Minaya, senior managing director, TIAA-CREF Asset Management. “Adding agriculture or timber, for instance, improves a portfolio’s efficiency frontier and Sharpe ratio [returns in excess of the risk-free rate]. Also, the different types of real assets are not correlated with one another, further increasing the diversification benefit of the asset class.”
Private or listed?
Investors can gain exposure to real assets through private ownership or listed strategies that may focus on a specific class, such as real estate, or a multi-asset package.
Private investments in relatively illiquid categories of real assets—farmland, timberland and commercial real estate—have generated higher returns than traditional investments, with significantly lower volatility, according to a TIAA-CREF report. However, it can be difficult for smaller investors to access the private market without the support and resources of a large institution, notes Minaya.
“Traditionally, many investors have turned to a private equity fund that invests in real assets,” he says. “However, those investments typically are driven by a short-term exit strategy rather than a long-term hold that generates continuing cash flows from an asset.”
Because private real assets are not a large part of an investor’s portfolio, the challenge is spending the time to understand the nuances of each asset, says Jim Gasperoni, head of real assets, Aberdeen Alternatives. “We believe specialized managers are best suited for investing in areas like timber, agriculture, mining and oil and gas,” he says. “When looking at newer strategies like renewable energy, managers who can look at those fields, along with traditional power assets like gas-fired plants, may be best suited for understanding the underlying economics of these strategies.”
While private strategies may be well suited for long-term investment objectives, listed real asset strategies provide flexibility to adjust to changing market conditions or other factors.
“More institutional investors are adding liquidity to their real asset portfolios,” says Dunn. “When you invest in listed real assets, you have daily valuation and daily liquidity with no lockups. That makes it easier to build a global portfolio and allows you to make tactical adjustments more quickly. However, you need to be comfortable with the equity wrapper around the assets.”
Brad Case, senior vice president for research and industry information, National Association of Real Estate Investment Trusts (NAREIT), says REITs typically provide 11 to 12 percent long-term returns through a typical real estate cycle. “The best performance has been by self-storage REITs, which are often overlooked by institutional investors,” he says. “They have averaged 17.5 percent annual returns for the past 22 years.”
Case notes that there can be a difference in values between publicly traded real estate and privately held properties. “Changes in investor sentiment show up on the public side of the market first, because of its higher liquidity,” he says. “It can take a half year or more before those valuation changes are reflected in transaction prices in the private market, and another quarter or two for appraisals to catch up.”
However, many investors are not seeking immediate returns in real estate, Case adds. “We are seeing a continuing inflow of capital from international investors looking for a safe place to park their money,” he says. “Rather than maximizing returns, they are very happy to purchase illiquid assets, regardless of valuation issues. Capital preservation is the big motivating factor, and real estate can help them meet that goal.”
Case adds that the U.S. real estate market should see continued growth in 2016. “We’re at a good stage in the cycle,” he says. “The macro economic indicators point to slow and steady growth. Construction remains low in virtually every type of commercial property, and a limited amount of new supply will support improvements in occupancy rates and rental growth for several years.”
Evolving opportunities in real assets
Real estate continues to dominate the real asset sector, as investors feel comfortable with the ownership fundamentals of both private and listed properties.
For example, New York-based Tunbridge Partners recently raised $500 million to invest in established managers who focus on real estate and real assets.
But there are many opportunities to acquire other types of real assets that can generate income, protect against inflation and provide return opportunities. Dunn says master limited partnerships (MLPs) that invest in natural-resource infrastructure may be an undervalued asset at this time.
“Until last year MLPs were the fastest-growing segment in the asset class,” says Dunn. “But with the dislocation in the energy markets, investors have been reassessing their positions. We believe that the long-term fundamentals for MLPs remain strong and lower valuations make them attractive, despite lower growth projections. Today they have an appealing risk-return profile with potentially higher yields than other investment strategies.”
Gasperoni also sees opportunities to take advantage of lower prices in the oil and gas sector. “With our focus on the private markets, we look for high-quality assets that can fare better in lower commodity price environments,” he says.
Minaya points to farmland and timber as other real asset categories with long-term potential. “By owning real assets, an investor is growing or producing an essential need for society, such as food, shelter, clothing or energy,” he says. “That production can continue in perpetuity, potentially increasing in value while delivering ongoing income. One fact we can count on is that there will be more people on the planet needing more resources, so the long-term trend for real assets is favorable.”
Many investors are using multi-asset strategies to gain exposure to this class in a way that can reduce overall portfolio risk. For instance, Dunn says a mix of global and U.S. REITs and listed infrastructure, combined with commodities and natural-resource equities, can provide important diversification benefits to an investment portfolio, as well as offer an attractive risk-return profile.
“There are many ways to invest in multi-asset solutions, so you have to determine your priorities,” adds Dunn. An investor with a separate allocation to inflation-linked fixed income might prefer a more equity-oriented multi asset strategy. On the other hand, an investor without an allocation to TIPS might look for strategies that include such an allocation as a more significant part of a real asset solution.
Dunn believes multi-asset strategies will gain more traction in the defined contribution (DC) market. “They are much easier for participants to understand.”