4 Reasons to own real assets today

4 Reasons to own real assets today

Vince Childers, CFA

Head of Real Assets Multi-Strategy

More by this author

15 minute read

April 2022

Share

Download Report

Liquid real assets—including real estate, infrastructure, natural resource equities and commodities—may be a particularly compelling allocation in today’s inflationary environment, offering diversification potential, historically competitive returns and valuations near multi-decade lows.

KEY TAKEAWAYS

 

  1. Outperformance in inflationary periods
    Real assets’ positive inflation sensitivity can protect against the potentially damaging effects of accelerating inflation on a portfolio concentrated in stocks and bonds.
  2. Diversification potential
    Distinct performance drivers generally result in differentiated behaviors from broad equities and fixed income.
  3. Historically strong returns with less volatility
    Real assets may improve risk-adjusted portfolio returns without sacrificing the potential for equity-like returns over time.
  4. Priced at attractive relative discounts
    Valuations relative to equities—even after real assets’ strong returns since 2021—remain compelling.

1. Outperformance in inflationary periods

Inflation—and, more importantly, inflation surprises—climbed to a 40- year high at the end of 2021, driven by global supply chain issues. This environment has persisted, amplified by unexpectedly strong wage inflation and further commodity supply shocks stemming from the war in Ukraine and subsequent economic sanctions leveled against Russia.

The one factor common to all real assets is their positive sensitivity to inflation surprises. The reason for this is simple: inflation often affects both asset prices and revenues of real assets, either directly through contractual inflation linkages or indirectly through fundamental economic drivers. This ability of real assets to counter inflation offers potential benefits to portfolios both in the short term, as prices climb, and in the longer term, should inflation rates continue to surprise to the upside.

The result of these inflation relationships has historically been strong returns in environments of rising and unexpected inflation, whether looking at individual real assets categories or a diversified real assets blend (Exhibit 1).

EXHIBIT 1
Real assets have historically outperformed in inflationary environments

Average annual real returns in periods of rising and unexpected inflation
June 1991–March 2022

Average annual real returns in periods of rising and unexpected inflation

2. Diversification potential

The goal of portfolio diversification is to own asset classes that tend to experience their above- and below-average returns in different economic and market environments—when one asset zigs, the expectation is that another will zag. Real assets’ distinct economic sensitivities tend to differentiate them from traditional risk assets such as stocks and bonds.

Diversification potential

The historical benefits of these differentiated economic drivers can be seen in real assets’ “beta,” i.e., their sensitivity to the broad global equity market (Exhibit 2). A beta of more than 1 indicates that the asset class (over the timeframe being analyzed) exhibits more volatility than the broad equity market. A beta of less than 1 indicates that the asset class tends to behave differently or be less volatile than the market. In this case, the low market beta of real assets suggests significant diversification potential, which may help to reduce portfolio volatility—and, we believe, improve risk-adjusted returns.

EXHIBIT 2
Low market beta suggests significant diversification potential
Beta to global equities

3. Historically strong returns with less volatility

Real assets have historically generated strong returns over full market cycles, with all but commodities delivering performance in line with or better than global stocks over the past 30 years (Exhibit 3). The long-term average for commodities was depressed by a decade-long bear market from 2008 to 2018, driven by the perfect-storm anomaly of (1) China’s orchestrated downshift in demand, (2) significant technological advances in oil and gas drilling, and (3) a decade of low interest rates and cheap access to capital— all of which drove a prolonged commodity oversupply cycle. However, commodities have since experienced substantial improvements in supply/ demand fundamentals, including strong global post-Covid reopening demand, tight inventories and a more supportive macroeconomic backdrop, providing potential catalysts for a sustained multi-year recovery.

The results below also demonstrate the potential benefits of combining multiple real assets within a single portfolio. Individual real assets categories can be quite volatile. However, combined into one strategy, a diversified real assets blend has historically delivered competitive returns with significantly less volatility than global stocks, capitalizing on diversification benefits available within and among the different categories.

EXHIBIT 3
Real assets may improve risk- adjusted performance

Annualized nominal returns and risk
June 1991–March 2022

Annualized nominal returns and risk

4. Priced at attractive relative discounts

The 2010s were characterized by repeated and unprecedented disinflation surprises, which weighed on real assets returns even as the broad equities market climbed ever higher. This has resulted in historically attractive real assets valuations relative to equities—even after the group’s strong returns since 2021 (Exhibit 4).

We believe today’s low relative prices are just one reason why the recovery in real assets may still have a long runway. Catalysts for a multi-year period of outperformance include:

  • Supply shortages across labor, product and commodity markets continue to impact inflation dynamics, with supply-side discipline in commodities production expected to persist.
  • The combination of elevated public spending, peak globalization and the “war on inequality” may sustain higher inflation over the coming decade, potentially weighing on stock and bond returns.
  • Central banks are likely to tighten financial conditions into slowing economic growth. Real assets typically outperform traditional stocks and bonds during “stagflationary” periods of lower-than-expected growth and higher-than-expected inflation.
EXHIBIT 4
Most real assets are trading near 20-year lows relative to stocks

Valuations vs. global equities
January 2000–March 2022

Valuations vs global equities

Benefits of the blend

Individually, real assets have merit; together, in a diversified framework, a strategic allocation in real assets can offer tremendous utility to investors who are concentrated in traditional equities and fixed income (Exhibit 5).

History shows that including real assets in a portfolio may provide key benefits, including the potential for:

  • Inflation sensitivity
  • Greater portfolio diversification
  • Attractive risk-adjusted returns over full market cycles

Moreover, real assets currently trade at attractive valuations relative to equities. We believe this combination of potential inflation benefits, diversification and relative value represents a compelling opportunity to realign portfolios to take advantage of what real assets can offer.

EXHIBIT 5
Real assets’ characteristics
Qualitative criteria based on Cohen & Steers long-term expectations

Our approach to designing a multi-strategy portfolio

Although every investor’s needs are different and there are many ways to make an allocation to listed real assets, Cohen & Steers offers a multi-strategy solution that we believe may effectively address the three objectives of inflation protection, diversification and long-term return potential.

Our unique approach is grounded in active management. Bottom-up fundamental analysis is combined with dynamic top-down asset allocation to further enhance potential returns. Risk management is an ever-present part of the equation, and we generally seek exposure to additional diversifiers (e.g., smaller allocations to gold and short-duration fixed income) to help further manage portfolio risk over time.

This approach allows investors to implement a well-diversified allocation to real assets through a single holding, managed by specialists with a deep understanding of the asset classes.

ABOUT THE AUTHORS
Author Profile Picture

Vince Childers, CFA, Senior Vice President, is Head of Real Assets Multi-Strategy and a portfolio manager for Cohen & Steers’ real assets strategy.

FURTHER READING

Recession and the roadmap for listed and private real estate

September 2022 | 17 mins

We see an economic backdrop that will create an opportunity for strong vintage returns for both listed and private real estate. Both cyclical and secular shifts are likely to create investment opportunities, and we think allocating across both private and listed real estate will be critical.

3 reasons to consider preferreds when rates are rising

September 2022 | 10 mins

Preferred securities have characteristics that can potentially help mitigate the effects of rising interest rates.

Strong foundations: The case for real estate securities

August 2022 | 37 mins

Listed real estate offers access to high-quality assets with strong growth potential, providing an efficient, liquid vehicle for investors seeking the unique benefits of the asset class.

1984232