SprottWealth Insights

Real Assets as a Core Portfolio Complement

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There are many definitions of “real assets”, but according to Mike Underhill, Chief Investment Officer at Capital Innovations and sub-advisor to Sprott Asset Management, a common definition is that they are investments in tangible “hard” assets like real estate (including REITs) and infrastructure. They can also include commodities and related investments such as timber land, farm land, and natural resources.

One reason that favours investment in Real Assets is the argument that the current economic outlook suggests a weaker market for traditional investments like equities and fixed income:

 

Bond yields are low

In the years since the global financial crisis of 2008, central banks around the world have flooded capital markets with liquidity, driving government and corporate bond yields to historic lows. As a result, many investors feel that these instruments no longer provide sufficient current income, particularly when considering the risk of rising inflation.

 

Ten-year government bond yields, 1990-2015

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Equities are near all-time highs

For two years, the market has been puncturing resistance and finding new all-time highs, over and over again. In addition, global uncertainty has also had the effect of producing significant volatility in the market. While rising markets are not cause to panic, as valuations rise to “above average” levels it does make sense to consider ways to manage the possible risk these valuations present.

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How can Real Assets help?

Real Asset investments can complement a core portfolio by providing the potential for uncorrelated income and growth, while adding inflation protection, and decreasing portfolio volatility:

 

Stable, revenue-oriented investments

The long lifespan of typical public/private infrastructure contracts and the durability of the assets help provide steady cash flows from fees.

 

Portfolio diversification

Real Asset securities have historically shown low correlation to traditional equities and fixed income.

 

Consistent demand

Real Assets and associated services are often necessities and therefore the demand for them is less sensitive to price changes

 

Growing need for infrastructure

OECD projects the level of investment needed to meet growing worldwide infrastructure demand will equal 3.5% of world GDP through the year 2030, or more than $55 trillion. The areas in most need for investment are expected to be development and modernization of roads, power networks, water systems and telecommunication networks. In the U.S. alone, the estimated infrastructure investment needed by 2020 is $3.6 trillion.

 

Inflation hedge 

Replacement costs of physical assets increase with inflation, typically causing the value of Real Asset investments to appreciate. What’s more, infrastructure contracts typically link fees to inflation measures, allowing for inflationary price increases.

Many Institutional Investors, faced with the same investment challenges we all have, have gone from zero allocation to Real Assets in 2000, to allocations of over 17% as of 2014:

Canada Pension Plan

17.7%

OMERS

28.1%

Ontario Teacher’s Pension Plan

23.0%

Source: Finding Investment Opportunities: Where to go in a Low Interest Rate Environment, 2015

Michael Underhill provides an interesting 90-second synopsis on the value of Real Assets as a complement to core equities and fixed income in this video:

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Password access: spw2016

 

Risks and Opportunities

Mike Underhill points out that there are country risks, company risks, and security risks associated with Real Asset investing, but that these risks can be mitigated by achieving exposure to Real Assets through the equity of companies whose primary businesses are in these categories.

Investing in the stocks of these companies provides the investor with exposure to Real Assets, and also provides an enhanced element of managerial oversight that comes with investing in the management teams of these companies. In addition, investing in Real Asset-related equities creates a much more liquid and transparent investment.

 

Sprott Asset Management has a Real Asset mutual fund that may be a suitable investment for you. We invite you to speak with your Advisor if you’d like to learn more.