There are many interpretations of what constitutes a “real asset”, but according to Michael 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), infrastructure, and shipping. 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 they can be looked upon as an asset class that could protect a portfolio over the long-term against inflation:
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 are concerned that these instruments may not provide sufficient current income, particularly when considering the risk of rising inflation.
The prospect of rising interest rates is leading to a corresponding increase in concern over inflation. While current levels of inflation remain modest and do not appear to represent a near-term threat, the potential for rising costs over the medium-term is expected to lead investors to seek alternatives that offer a greater degree of inflation protection.
Although the global economy appears to have recovered from the recent financial crisis and pockets of growth have begun to re-emerge, overall growth remains subdued, with few visible catalysts to ignite a meaningful change in the trend. Despite this low-growth environment, interest rates are on the rise. In such an environment, investors will likely want to look beyond traditional equity and fixed income investments to add to their returns.
In today’s uncertain markets, Real Assets have the potential to provide sustainable yield, inflation protection, growth and portfolio diversification to help investors reach their financial goals. Investment in an infrastructure fund, for instance, can produce the following benefits:
The long lifespan of typical public/private infrastructure contracts and the durability of the assets help provide steady cash flows from fees.
Infrastructure securities have historically shown low correlation to traditional equities and fixed income.
Infrastructure assets and services are necessities and therefore the demand for them is less sensitive to price changes.
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.
Replacement costs of physical assets increase with inflation, typically causing the value of infrastructure investments to appreciate. What’s more, infrastructure contracts typically link fees to inflation measures, allowing for inflationary price increases.
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.