Real assets refers to physical, tangible assets such as real estate, infrastructure, commodities, and natural resources. Investing in real assets can provide portfolio diversification, inflation hedging, and attractive risk-adjusted returns. However, managing real assets investments poses challenges due to valuation complexities, illiquidity, high transaction costs and heterogeneity of the assets. This article explores the investment case for real assets and discusses best practices in real asset portfolio construction and management.
Real assets provide diversification benefits
Adding real assets to a portfolio of traditional stocks and bonds can lower overall portfolio risk through diversification. The returns of real assets have low correlations with traditional assets, providing diversification. For example, commodities like gold can act as an inflation hedge and hedge against event risks. Real estate generates income and its value often moves independently from the stock market. Infrastructure assets provide steady cash flows linked to economic growth.
Real assets provide an inflation hedge
Real assets have intrinsic value and pricing power which helps preserve capital against inflation erosion. Commodity prices generally rise during inflationary periods. Rental income from real estate can be indexed to inflation. Infrastructure assets with regulated returns or availability payments can provide inflation protection.
Real assets offer attractive risk-adjusted returns
Real assets have historically generated competitive long-term returns compared to stocks and bonds on a risk-adjusted basis. For example, real estate investment trusts (REITs) provide steady dividend income and capital appreciation potential. Commodities offer diversification along with upside potential from emerging market growth. Infrastructure investments benefit from stable, long-term contracts and high barriers to entry.
Challenges in real assets investment management
While real assets provide benefits, they also pose challenges for investment managers. Valuing real assets can be complex due to lack of active markets and comparable transactions. Many real assets like real estate are highly illiquid. Transaction costs like commissions and taxes can be high. The heterogeneous nature of real assets makes benchmarking performance difficult. Managers must have pricing expertise, access to deal flow, and resources to properly manage real asset portfolios.
Best practices in real assets portfolio management
A best-in-class real assets investment program should focus on portfolio construction, liquidity management, transparency and governance. Portfolio construction should balance return objectives with risk controls by investing across real asset categories, geographies and the risk spectrum. Liquidity should be managed to meet cash needs. Transparency on asset valuation and performance attribution is key. Strong governance practices for acquisitions, operations and dispositions are critical.
Real assets like real estate, infrastructure, and commodities provide portfolio diversification, inflation hedging, and attractive risk-adjusted returns. However, real asset investments require specialized management expertise to address the challenges. A well-constructed and managed real assets allocation can enhance portfolio efficiency and better position investors to meet their investment objectives.