Global Real Assets – a new asset class is forming
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What do we mean by ‘real assets’?
By our definition, ‘real assets’ refers to operating assets, hard or ‘tangible’ assets as well as financial securities that provide an implicit or direct hedge against inflation. Within this asset class, we include five main sub-sectors:
Real Asset
Inflation hedge created by:
Real Estate
Cost of construction, materials and labour
Infrastructure
Tolls and rates of regulated industries – often pegged to core inflation
Commodities, Timber & Agriculture
Direct link to basic materials, food staples and the energy sector
Clean Energy
Direct link to product/delivery of renewable & sustainable energy
Shipping
Direct link to global growth and movement of goods and materials
By their very nature, all these assets are directly linked to – indeed in some cases are even the key drivers of – domestic and global inflation. As such, they can provide the simplest and most effective protection against inflationary risks.
Other beneficial features for pension funds
The advantages of real assets are not limited to inflationary protection; their investment benefits can also include: i) ‘Equity-like’ growth – commodities, real estate and infrastructure have all demonstrated their ability to deliver long-term growth that’s comparable to equities. For example, over the last 20 years annualised returns from commodities have exceeded those from global equities. Since infrastructure indices do not go back very far, we have constructed a proxy by measuring the growth rate of cash flows in more than 250 infrastructure assets/companies in OECD countries over 20 years. On average the growth rate of cash flows has been 5%. Together with their natural inflation hedge, Real Assets offer the potential to maintain strong ‘real’ returns over the long term. ii) Strong, steady cashflows – infrastructure and real estate can both generate highly reliable cashflows through, for example, rentals on office space, tolls on bridges and roads, and the regulated pricing on utilities. This can provide a pension fund with the opportunity to use real assets to deliver bond-like income to match their liabilities. iii) Low correlation with other assets – commodities and infrastructure have both demonstrated very low correlation with equities. Since 1970, the S&P Goldman Sachs Commodity Index and the MSCI World Index have delivered negative returns in the same year only three times, in 1981, 2001 and 2008. As for infrastructure, our own analysis has shown us that the correlation co-efficient between cashflows from US equities and US infrastructure from 1986 to 2006 was just -0.1. Sustained low correlations suggest that real assets can act as a powerful form of diversification within an equity-focused portfolio, helping to lower overall risk. iv) Reduced volatility – Long-life stable assets with growing cashflows such as real estate and infrastructure have shown they can offer comparable returns to equities, yet their stable cashflows mean they deliver these returns with significantly less volatility. In other words, real assets can provide a compelling combination of investment attributes: equity-like real growth combined with bond-like cashflow generation, plus the opportunity to reduce overall portfolio risk without any corresponding fall-off in investment returns.
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