A solid investment strategy requires the management of risks. When the financial markets experience volatility or there is a growing concern over future inflation risks, investors tend to diversify their portfolio by looking for investment alternatives to fixed assets such as stocks and bonds. In these circumstances, one asset class investors look to inject into their portfolio in order to create a more diverse level of exposure, is Real Assets.
What is a Real Asset?
What is considered a ‘real asset’ is up for debate. In an investment sense, a real asset is defined as “a good that is independent from variations in the value of money.” This real asset definition can open a wide array of interpretations. What separates a real asset from a fixed asset, is that a fixed asset gets its value from being a contractual claim on an underlying asset that can be intangible or real.
For the sake of this article, real assets will include objects which institutional investors can generally agree as being a real asset such as: real estate and land (real property), precious metals, and natural resources such as fossil fuels, and commodities like agricultural raw materials.
Why Hold Real Assets?
In simple terms, capital preservation and growth are the main reason for holding real assets. But when looking at an expanded view, the reasons for holding real assets as part of an investment portfolio can be separated into 4 main categories.
(1) Inflation protection
Although the near term risks of an inflation spike are currently low, over the long run of three, five, and ten-year time periods, real assets have shown a very low correlation to fixed financial assets such as stocks or bonds. This makes real assets an effective hedge against rising inflation rates. As inflation increases, fixed assets like bonds lose value in real terms. Conversely, real asset prices remain relatively stable or increase.
(2) Market Volatility
The financial aftermath of the United Kingdom’s vote to ‘Brexit‘ from the European Union is one recent example of events that can create instability in the world’s financial markets. The United States has since shown a resilience to “Brexit. However, multiple other factors, domestically and internationally, continue to fester market uncertainty. To many investors, real assets, such as precious metals have served as insurance against economic risks and geopolitical instabilities that affect the world’s financial systems.
The old adage, ‘never put all your eggs into one basket’, most certainly holds true when it comes to investment portfolios. There are constant changes created by financial market cycles and unforeseen events. Having only fixed assets such as stocks and bonds in a portfolio can create significant and volatile swings in value. A person needs only to recall the effects of the Great Recession to understand how volatile the market can be. The number of publicly traded businesses that went under, loss of confidence, and resulting panic, created a loss of trillions of dollars of household wealth in America alone. In order to create a relative level of stability and minimize portfolio risks, investors can diversity their portfolios with real assets.
(4) Income Generation
The counter-cycle nature of real assets versus fixed assets benefits an investment portfolio by helping achieve better risk adjusted returns. In down markets, publicly traded companies are less willing or able to pass along earning to its investors, in the form of quarterly dividends or payouts. On the other side of token, real assets such as real estate properties can still generate income for an investor, regardless of financial market conditions. Investments in commodities and natural resources, are also able to continue producing returns for an investor because the demand for things like agricultural goods and fossil fuels remains constant, if not growing. As populations increase and supplies become more limited, the value placed on real asset goods will increase.
The quest for portfolio stability and consistent capital growth creates a need for alternative investment solutions, such as real assets. When the market enters into a downward cycle, the growth potential and risk mitigation benefits of real assets will likely trend towards greater heights.