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#Investments — 11.07.2017

Weighting Asset Allocation Towards Real Assets…

Jean-Patrick Mousset

…a way of protecting your portfolio against inflation

What Exactly Is A ‘Real’ Asset?

What Do Real Estate, Farmland, Vineyards, Forests, Infrastructure, Gold And Commodities Have In Common?

They are all what are known as ‘real’ assets, or tangible assets, whose value is based on their physical properties or utility (as opposed to financial assets).

 

Why Invest In Real Assets?

Inflation is one of the risks that can have a major impact on the value of, and returns on, assets in the long term. Inflation may be caused for example by expansionist monetary policy, a scarcity effect with regard to certain commodities and raw materials, or weakness in the investor’s reference currency.

One of the advantages of real assets is that they provide a good hedge against inflation, offering downside protection during periods of volatility, and benefiting from the scarcity effect. Highly popular with long-term investors, these assets also appeal to private investors looking to protect the annual income on their holdings from price rises.

More specifically, real assets cope well with unanticipated inflation, i.e. the difference between actual inflation over a given period and prior forecasts of the inflation rate over the same period. This is important, as inflation may have a particularly severe impact on assets that generate fixed annual returns.  

While all real assets share this inflation-hedging effect, their precise characteristics vary:
 

  • To hedge against short-term inflation, one would usually go for commodities, whereas real estate is more suitable as a long-term inflation hedge, and investors tend to choose gold as a more general diversifier for a traditional portfolio of equities and bonds.
  • Alternatively, one might prefer cyclical real assets (commodities, REITs) or more defensive assets such as gold or inflation-indexed bonds, e.g. Treasury Inflation-Protected Securities (TIPS) – which are also by extension regarded as real assets
  • If you would rather focus on listed assets, you can choose between inflation-linked bonds, REITs, infrastructure sector equities, gold, or invest in commodities via Exchange Traded Funds (ETFs) or by for example buying mining company equity.  If on the other hand liquidity is not a constraint, then you should consider unlisted assets, investing directly in real estate, vineyards, forests and rural land.

In all cases, most real assets will provide an inflation-linked return, a definite attraction for investors in search of stable recurring revenue. In the past, real assets have been seen to provide good protection when inflation is rising.


So What Weighting Should Be Given To Real Assets In Your Portfolio?

If you are a private investor, the proportion of real assets in your portfolio will depend variously on your  macro-economic views, your risk appetite your time horizon and your degree of loss-aversion. And while real assets can certainly help to build portfolios that generate recurrent returns and are likely to prove robust in the face of any eventual resurgence in inflationary risks or a return to periods of volatility, it remains vital, as always, to ensure good diversification within this compartment of your portfolio.

Real assets, traditional assets, alternative assets - all have a role to play in portfolio allocation. And then it always remains to find the right mix to meet your objectives, as we explained in "Why Asset Allocation Is King".


Example: The endowment funds of major US universities such as Yale and Harvard have a 20% real asset weighting, mainly in real estate and natural resources. For these investors, whose investment horizon stretches to infinity, incorporating these assets into the portfolio is an indispensable way of protecting their returns against inflation in the long run.