KUWAIT: Real assets are physical/tangible assets with intrinsic value, independent of market conditions. They include properties, land, agriculture, natural resources, and infrastructure. Investors are drawn to real assets for diversification, protection against inflation, and income generation through sources like rental payments and capital appreciation. For example, real estate can provide rental income while appreciating in value. Additionally, commodities like gold can hedge against inflation. Overall, real assets are essential for a stable and diversified investment strategy, especially in uncertain economic conditions.
Types of real asset investments
Real assets investments can be classified into four main categories, each with its own unique sectors.
Investors can participate in both public and private markets to gain exposure to real assets. However, it is important first to understand the main factors influencing risk and expected returns for each type of investment and how they relate to an investor’s time horizon, risk tolerance, availability of capital, and liquidity constraints. Depending on these factors, exposure to public markets, private markets, or a combination of both may then be suitable.
Public markets
Typically, investors with short-term horizons and needing immediate liquidity can take advantage of publicly traded equity in companies related to real estate, infrastructure or natural resources. This exposure can be accessed through sector-specific mutual funds, real estate investment trusts (REITs), or exchange-traded funds (ETFs) using active or passive approaches, respectively. While these strategies offer liquidity, they are also subject to volatility, similar to the overall equity market.
Private markets
For investors with substantial capital and a long-term horizon, allocating capital to private investments in real assets can offer benefits. These investments often exhibit lower volatility and more accurately represent desired characteristics compared to public market counterparts. However, building and managing a private market portfolio requires significant research resources for due diligence and monitoring, and the elevated minimum commitment size may restrict the flexibility to create a diversified portfolio.
Income generation in real assets
Real assets like real estate and infrastructure are great options for investors looking for both income and capital appreciation. These assets generate income through rent payments and offer predictable and resilient cash flows. Real estate investors have earned a long-term yield premium of 3.7 percent compared to US government bonds, while infrastructure investors have earned a premium of 3.6 percent over the past 15 years (measured against listed real estate and infrastructure).
• Infrastructure and real estate investments typically offer higher yields compared to US government bonds.
• As of mid-2022, the yield spreads for these investments narrowed or turned negative, indicating reduced attractiveness in a low-risk context.
• Despite this, other factors such as capital appreciation, diversification, and inflation protection make a strong case for investing in real assets.
• The historically high yield premiums of real assets suggest potential for strong income generation.
Performance of real assets in varying economic conditions
Real assets play a crucial role in investment strategies, especially during economic downturns and inflationary periods. They act as a strong defense against rising prices and can help retain or increase their value when equities and bonds are vulnerable to inflation. Real assets, such as real estate and commodities, derive their value from physical assets and serve as effective inflation hedges. They also provide further diversification in an investor’s portfolio due to their lower correlation with traditional asset classes.
The benefits of real assets in a diversified portfolio
Introducing real assets to a traditional 60/40 portfolio (consisting of equities and bonds) can enhance portfolio diversification by providing both income generation and capital growth, eventually contributing to a more stable return expectation. The benefits of real assets in a mixed portfolio, inter alia, are derived in part from their historically low correlation to bonds. For example, natural resources exhibited over the past 20 years, a nearly uncorrelated relationship with bonds at 0.02, while infrastructure and real estate investments also demonstrated a low correlation of 0.30. However, all real assets displayed stronger correlations with equities over the same period. Despite their high correlations with equities, it is important to highlight that, real assets in general, enhance diversification in a traditional 60/40 portfolio and provide unique advantages not found in equities, which could offset their positive correlation with equities.