Until recently, real asset investments have been somewhat downplayed due to the very low interest and inflation environments. Right now, it is imperative that every smart investor diversifies into real assets to protect their purchasing power and capital to generate competitive risk-adjusted returns. The institutional investors and family offices are increasing their allocations to real assets because of the associated attributes and benefits, and so should you.
WHAT ARE REAL ASSETS
Real assets are mostly physical or tangible assets that have their inherent value derived from or tied to their characteristics (physical and otherwise) and ability to produce goods or services. Simply put, real assets are what make us function as a society. The framework and resources that facilitate everyday activities in the world.
REAL ASSETS fall into 3 Classes
- Real Estate: These are lands and properties like commercial buildings, single family homes, apartments, offices, warehouses, self-storage, hostels, resorts, hospitals, malls, etc.
- Infrastructure: These are assets, systems, and networks used for transportation (subways, bridges, roads, railroads, airports, and shipping ports); energy (utilities, power-generation plants, refineries, and oil & gas pipelines); social services (hospitals, schools, and other public buildings); and communications (wireless towers and other telecom facilities) etc. Infrastructure provides the foundation of basic services, facilities, and institutions on which communities depend for growth and development.
- Natural Resources: These resources are used to make food, energy, and raw materials/ inputs required for the production of other goods. Examples include farmlands, animals, birds, fish, plants, trees, air, sunlight, soil, and water as well as oil, natural gas, stone, sand corn, soybeans, precious metals like gold and silver, etc.
“There is no life without Real Assets”
BENEFITS OF INVESTING IN REAL ASSETS
Demand for real assets investments has grown in recent times. This trend is highly likely to continue as more people, not just institutional investors and family offices, have a better understanding of the attributes and benefits. These include portfolio diversification, inflation hedging, long-term passive income, competitive total return potential, value appreciation, store of value, and tax benefits. The performance drivers for real assets are fundamentally diverse from other types of securities.
- Portfolio Diversification
Investors typically turn to real assets as an effective way to diversify their portfolios due to the low to negative correlations they have with the public markets. Some real assets also have a low correlation to other real asset classes. For optimal risks and returns diversification, a portfolio should comprise of asset classes with negative correlation and zero correlation.
During economic recessions which result in high unemployment and public markets performance decline, governments significantly increase their infrastructure investments and also incentivise the private sectors to do the same as a means to significantly boost economic activities and create jobs. Due to the positive correlation between the public markets and economic performance, investing in infrastructure is a good diversifier. Furthermore, most infrastructure investments continue to appreciate and offer growth potential during economic booms.
Having real assets in your investment portfolio diversifies the risks, and minimise losses during market depressions but remains exposed to the market upsides in economic expansions.
- Inflation Hedge
The relationship between commodities price changes and the changes in prices that consumers pay for goods and services is natural. As the oil price of increases and supply chain challenges continue, consumers will pay more for goods and services.
As a result of the natural relationship, having real assets in a portfolio is a perfect hedge against inflation. Real estate, farmland, commodities, and some infrastructure projects are most positively correlated with inflation.
Through inflation-linked rent rate escalation in leases, rental properties provide good protection against inflation. In most infrastructural projects, the contracts or concession agreements have a price/rate escalator tied to inflation. For example, the power & utilities project contracts (power purchase agreement – PPA ) prices are reviewed and adjusted for local inflation periodically.
- Long-Term Holding and Stable Income
Horizons of real assets investment are very long-term with pre-determined streams of contractual income as they are fee-for-use in nature through leases, contracts, and concessions. This is particularly true for real estate and infrastructure assets which are cashflow generating assets. For instance, a power or toll-road infrastructure will typically have 5-50years contracts or concessions that produce year-on-year predictable passive income to investors.
These long-term buy-and-hold strategy investments benefit investors as they continue to enjoy a stable income, while the assets appreciate in value without the rush to exit. Even in rising interest rate environments, real assets are positioned to perform better due to stable cash flow.
- Value Appreciation
Since most real assets are physical or hard in nature, they are limited in supply. Notwithstanding the limited supply, the demand for real assets use continues to grow as the population grows. The amount of land available (supply) to build new houses or farm or mine is limited, and cannot be increased to meet the growing demand. Consequently, the value continues to appreciate over time with demand. Investors continue to enjoy significant capital gains in addition to the stable operating income being enjoyed over time.
- Store of Value
Real assets have intrinsic value due to their physical substance, not just from the contractual right or ownership claim income. Hence they maintain and store value over time rather than depreciate. Some have perpetual shelf lives and remain intact without any significant maintenance or operating costs.
Precious metals (gold, silver etc) are the most classic example of store of value assets as their value have been maintained for thousands of years. They are the ultimate “safe-haven” assets in times of economic downturns. Others include rare and desirable collectibles like coins, watches, artwork even cars. Real estate and farmlands are also great examples due to their tangibility and utility but they require some level of maintenance and are susceptible to unexpected and sudden downturns.
- Competitive Total Returns
Due to all the foregoing attributes and benefits, real assets offer investors competitive total return potential. The contractual income claims are inflation-protected, risks are diversified, and values are preserved. While financial assets (public stock and bonds) values are declining, real assets values rise or remain neutral. So, the two return components of total return – cash flow/income and gain in value (capital gain) in real assets help to deliver competitive risk-adjusted returns.
- Tax Benefits
Real asset investments enjoy one form of tax incentives or the other. Tax incentives involve exemptions, deductions, exclusions, and credits. The tax benefits could be through depreciation deductions, pass-through structures, tax-exempt government-issued bonds, tax credits, and/or deferred tax programs like opportunity zones. To incentivise private investors, governments use tax incentives to encourage private investors to invest in infrastructure and real estate.
Governments leverage private capital to create larger funding to address infrastructure needs to drive economic growth and create jobs. Even where taxes are only deferred and later recaptured (paid) when the assets are later sold for profit, the investors may still pay less taxes due to the time value of money (the same amount of money now is worth more than in the future).
Not for short-term focused investors seeking high returns in a short period.
Investors should consider allocating more real assets into their portfolio after taking into account their investment objectives, constraints, and risk-tolerant level including the risks and benefits.
Real assets attributes of portfolio diversification, inflation hedge, long-term income, value appreciation, competitive total return, store of value, and tax benefits provide attractive consideration in portfolio allocation. In our opinion, the focus should be on cash-flow generating, de-risked, established value-add, inflation-linked, low-to-negative correlated, capital preservation with growth potential real assets.