Vince Childers, CFA
Head of Real Assets Multi-StrategyMore by this author
22 minute read
May 2022Download Report
Real assets—including real estate, infrastructure, commodities and resource equities—may offer an effective solution amid inflation risks.
- Inflation may be persistent
Rising consumer prices are driving demand for asset classes with the potential to perform well in inflationary environments—a characteristic central to listed real assets.
- Why real assets
A blend of real assets offers the potential for some level of inflation sensitivity, diversification and enhanced risk-adjusted returns, with lower historical volatility than individual real assets.
- Why now
Real assets are trading at attractive levels relative to equities. This, combined with high and broad-based inflation, is raising awareness of their potential benefits.
Inflation may be persistent
Inflation has surged to near 40-year highs, and evidence is mounting that the spike in prices is more than temporary. A major shift in the drivers of this business cycle vs. prior expansions points to enduring inflation and a prolonged environment favorable for real assets.
In the last economic cycle, the slow and shallow recovery following the global financial crisis was characterized by deflationary globalization forces and insufficient aggregate demand (due to deleveraging in the private sector). Consequently, Organisation for Economic Co-Operation and Development (OECD) core inflation averaged just 1.8% annually between 2010 and 2020.
In stark contrast, the economy’s rapid recovery from the Covid pandemic has been characterized by inflationary forces (wage/price pressures) and insufficient aggregate supply to keep up with an over-stimulated private sector. This convergence of supply and demand pressures is jointly driving inflation higher (Exhibit 1). Moreover, the longer the Russia–Ukraine war continues, the higher the likelihood that supply disruptions will endure.
Inflation is therefore likely to stay well above the previous cycle average, in our view.
As today’s strong demand and impaired supply point to persistent inflation forces, investors may want to consider real assets, which often have built-in inflation escalators or may benefit directly from rising commodity prices. It is key for investors to consult their financial professional concerning their
investment objectives, financial position and risk tolerance before making any investment decision.
Inflation is high and broad-based
OECD consumer prices (y/y % change)
January 1970–March 2022
At March 31, 2022. Source: Refinitiv Datastream, Cohen & Steers.
Past performance is no guarantee of future results. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. Core inflation is a measure of inflation that excludes certain items that face volatile price movements because in finding out the legitimate long run inflation, short-term price volatility and transitory changes in price must be removed. Core inflation is most often calculated using the consumer price index (CPI), which eliminates products—usually those in the energy and food sectors—that can have temporary price shocks because these shocks can diverge from the overall trend of inflation and give a false measure of inflation. Headline inflation reflects the long-term trend in a particular price level, but does not exclude any items that face volatile price movements. See page 8 for additional disclosures.
Positioning portfolios for long-term inflation risk
Listed real assets can help defend against inflation. At Cohen & Steers, we define listed real assets as four core asset classes: real estate, infrastructure, commodities and resource equities. What unifies real assets more than any other attribute is that their returns have historically benefited from inflation surprises. In other words, this means real assets have tended to outperform during periods of rising and unexpected inflation, contrasting with the modest or negative inflation sensitivity of stocks and bonds (Exhibit 2).
The economic drivers of real assets are often directly or indirectly tied to inflationary trends; this linkage historically has resulted in outsized returns when inflation exceeds expectations. An allocation to real assets may therefore help to preserve future purchasing power, potentially offsetting the vulnerability to unexpected inflation that is historically common to traditional portfolios of stocks and bonds.
Real assets have historically outperformed in inflationary environments
Average annual real returns in periods of rising and unexpected inflation June 1991–March 2022
At March 31, 2022. Source: Barclays, Bloomberg, Dow Jones, FTSE, S&P, Refinitiv Datastream, Cohen & Steers.
Past performance is no guarantee of future results. Inflation measured as the year-over-year change in the Consumer Price Index for all urban consumers, published by the U.S. Bureau of Labor Statistics. Rising inflation is measured as a positive year-over-year increase in the 12-month inflation rate. Unexpected inflation measured as a positive difference between the year-over-year realized inflation rate and lagged 1-year-ahead expected inflation, as measured by the University of Michigan survey of 1-year-ahead inflation expectations. The real assets blend is not representative of an actual portfolio and is for illustrative purposes only. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. See page 8 for index associations, definitions and additional disclosures.
Why real assets
Three potential benefits
Real assets are the structures and raw materials that economies rely on to function and be productive. That includes the properties where we live, work and shop; the infrastructure
that provides power and water and enables transportation and communications; and the basic natural resources, such as food and energy, that sustain societies. Products that invest in publicly traded (listed) markets offer a convenient way to access the global opportunity set of real assets, capturing the underlying economics of these investments with the added benefit of liquidity.
A diversified blend of real assets—including real estate securities, listed infrastructure, commodities and natural resource equities— may help enhance a portfolio in three key ways:
- Positive inflation sensitivity to help mitigate the potentially damaging effects of accelerating inflation.
- Diversification potential from distinct performance drivers that typically result in low correlations, both among real assets categories and vs. stocks and bonds.
- Attractive return potential over full market cycles, with a history of attractive risk-adjusted performance.
The economic drivers of real assets are often directly or indirectly tied to inflationary trends, historically resulting in outsized returns when inflation exceeds expectations (and relative underperformance when inflation is low). For example, the release of pent-up consumer demand, which is one of the drivers
of inflation today, stands to benefit assets that struggled the most early in the pandemic such as commodities, natural resource equities, real estate and infrastructure.
An allocation to a blend of real assets may help preserve future purchasing power, potentially offsetting the weak or even negative inflation sensitivity of traditional portfolios concentrated in stocks and bonds. The ability of real assets to counter inflation may have an impact on portfolios both today, as prices climb, and longer-term if elevated inflation persists.
How real assets are tied to inflation
- Property values tend to rise with the overall price environment due to rising costs of labor, land and materials.
- Real estate companies typically have high operating margins and low labor costs.
- Some commercial leases have explicit rent escalators tied to inflation.
- Sectors with shorter lease durations can take advantage of reflationary rents relatively quickly.
- Cash flows and asset values may have direct or indirect links to inflation.
- For example, with regulated utilities, inflation is typically factored in when determining consumer rates and included in utility project costs that can affect a utility’s rate base.
- With marine ports, contracted rates typically include escalators if inflation exceeds a specified level.
- Commodities, such as grains, livestock and precious metals, frequently serve as direct inputs to inflation measures.
- Commodity prices tend to respond to economic forces, such as supply constraints and changes in global demand, that often drive the prices of other goods.
- Demand for essential resources such as food, energy and metals tends to be relatively inelastic (i.e., independent of rising or falling prices), which typically enables resource producers to pass through higher costs of labor, commodities and other inputs onto customers.
- As a result, prices for raw materials tend to rise with broader inflationary pressures, which may help increase cash flows and widen profit margins for producing companies.
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.
The historical benefits of having differentiated economic drivers can be seen in real assets’ “beta,” which is their sensitivity to the broad global equity market (Exhibit 3). 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.
Low market beta suggests significant diversification potential
Beta to global equities
June 1991–March 2022
At March 31, 2022. Source: Barclays, Bloomberg, Dow Jones, FTSE, S&P, Refinitiv Datastream and Cohen & Steers.
Past performance is no guarantee of future results. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend will begin. Beta measures the relative volatility of an investment as compared to a standard market index. A market index will always be equal to 1.00. An investment with a higher/lower Beta, more/less than 1.00, is more/less volatile than the market index. See page 8 for index associations, definitions and additional disclosures.
Attractive risk-adjusted returns
Real assets have historically delivered attractive full-cycle returns that can potentially improve risk-adjusted portfolio returns without sacrificing growth potential. Over the last 30 years, a blend of real assets has exhibited returns competitive to those of global stocks, but with lower volatility (Exhibit 4).
A balanced approach
Since 1991, a real assets blend has exhibited favorable risk-adjusted return.
At March 31, 2022. Source: Barclays, Bloomberg, Dow Jones, FTSE, S&P, Refinitiv Datastream, Cohen & Steers.
Past performance is no guarantee of future results. Return reflects compound annualized return. Risk reflects annualized standard deviation of monthly returns. Standard deviation, also known as historical volatility, is a measure of the dispersion of a set of data from its mean and is used by investors as a gauge for the amount of expected volatility. Sharpe ratio is a measure of risk-adjusted return, calculated by subtracting the risk-free rate from a return and dividing that result by the standard deviation. The higher the Sharpe ratio, the higher the risk-adjusted return. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. See page 8 for index associations, definitions and additional disclosures.
Benefits of the blend
A diversified blend of real assets may offer an effective way for investors to target common objectives of a real assets allocation—such as boosting inflation sensitivity, enhancing diversification and improving the risk-return profile— while potentially dampening the swings that investors may experience with separate allocations to individual asset classes (Exhibit 5).
Matching real assets characteristics to portfolio objectives
At March 31, 2022. Based on Cohen & Steers analysis and expectations.
There is no guarantee that any market forecast set forth in this presentation will be realized. The views and opinions are as of the date of publication and are subject to change without notice. The mention of specific sectors is not a recommendation or solicitation to buy or hold securities in a particular sector and should not be relied upon as investment advice. The qualitative criteria in the above chart represent relative strengths across the real asset categories discussed in this presentation, based on realized historical data since June 1991 and Cohen & Steers’ expectations.
Priced at attractive relative discounts
Resilience in the face of inflation, portfolio diversification and historically attractive returns through an economic cycle are three reasons an allocation to real assets in a diversified portfolio may make sense in most economic regimes.
Potentially adding to the group’s appeal are attractive relative valuations.
The 2010s were characterized by repeated and unprecedented disinflation surprises, which weighed on real assets returns even as equities 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 6).
Real assets are generally trading near 20-year lows relative to stocks
Valuations vs. global equities
January 2000–March 2022
At March 31, 2022. Source: Bloomberg, S&P Xpressfeed, Cohen & Steers proprietary analysis.
Past performance is no guarantee of future results. Valuation scores represent composites of various metrics: global equities/infrastructure/resource equities: cashflow-to-price, dividend yield and book-to-price; real estate:
FFO-to-price, dividend yield and book-to-price; commodities: weighted real spot price. Real estate, infrastructure and resource equities based on proprietary Cohen & Steers data for respective stock universes, constructed from the S&P Global Xpressfeed database. Global equities represented by Datastream World Index. Commodities represented by Bloomberg Commodity Index. The information presented above does not reflect the performance of any fund or other account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected above. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. See end notes for index definitions and additional disclosures.
We believe today’s low relative prices are just one reason why the recovery in real assets may still have time to run. Potential catalysts for a longer period of outperformance include:
Macro backdrop may favor real assets
- 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 and peak globalization may sustain higher inflation over the coming decade, potentially weighing on stock and bond returns.
- Central banks have begun to tighten financial conditions to combat high inflation, but they risk tightening so much that economic growth slows. Real assets typically outperform traditional stocks and bonds during “stagflationary” periods of lower-than-expected growth and higher-than-expected inflation.
Within an economy characterized by a regime shift toward higher inflation, and real assets generally trading near 20-year lows relative to stocks, an allocation may offer an effective way to boost inflation sensitivity, enhance diversification and improve a risk-return profile.
Why the commodities recovery may continue
Russia’s invasion of Ukraine in early 2022 has thrown a spotlight on commodities as virtually every sector—from energy to agriculture to metals—has surged on supply concerns stemming from the war. While a welcome de-escalation of the conflict could cause commodities to pull back for a spell, we believe the macroeconomic conditions that have driven many commodity prices to multi-year highs could remain very constructive over the longer term. We believe the potential for a lasting economic recovery bodes well for an extended period of strong commodity consumption.
Inventories for most commodities were at multi-year lows before the pandemic hit, leaving producers scrambling to meet the now surging demand as economies reopen. A lack of investment in supply in recent years means ramping up output will take time. Also, Covid-related production issues and supply chain constraints that plagued many sectors during the pandemic (particularly metals) are still lingering.
After a challenging decade for commodities, we see potential for a sustained, broad-based rally, driven by three key factors:
- A highly supportive macroeconomic backdrop
- The strongest supply/demand fundamentals in a decade
- Attractive portfolio benefits—including inflation sensitivity—driving speculative inflows
Index definitions and important disclosures
An investor cannot invest directly in an index and index performance does not reﬂect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may diﬀer from a particular investment.
Data quoted represents past performance, which is no guarantee of future results. There is no guarantee that any historical trend illustrated/referenced above will be repeated in the future, and there is no way to predict precisely when such a trend might begin. There is no guarantee that any market forecast set forth in this commentary will be realized. The views and opinions in the preceding commentary are as of the date of publication and are subject to change.
This material represents an assessment of the market environment at a specific point in time and should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or take into account the specific objectives or circumstances of any investor. We consider the information in this presentation to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing. The views and opinions expressed are not necessarily those of any broker/dealer or its aﬃliates. Nothing discussed or suggested should be construed as permission to supersede or circumvent any broker/dealer policies, procedures, rules or guidelines.
Real assets blend: 27.5% real estate, 27.5% commodities, 15% infrastructure, 15% resource equities, 10% short-duration fixed income and 5% gold. Real estate: Datastream Developed Real Estate Index through 2/28/05; FTSE EPRA Nareit Developed Index thereafter. The Datastream Developed Real Estate Index encompasses listed real estate companies in developed markets and is compiled by Refinitiv Datastream. The FTSE EPRA Nareit Developed Index is an unmanaged market weighted total return index which consists of many companies from developed markets that derive more than half of their revenue from property-related activities. Commodities: S&P GSCI Index through 7/31/98; Bloomberg Commodity Total Return Index thereafter. The S&P GSCI Index is a composite of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities, calculated on a fully collateralized basis with full reinvestment. The Bloomberg Commodity Total Return Index, formerly known as the Dow Jones-UBS Commodity Index, is a broadly diversified index that tracks the commodity markets through exchange-traded futures on physical commodities, which are weighted to account for economic significance and market liquidity. Infrastructure: 50/30/20 blend of Datastream World Gas, Water & Multi-Utilities, Datastream World Pipelines and Datastream World Railroads through 7/31/08; Dow Jones Brookfield Global Infrastructure Index thereafter. The Datastream World Index Series encompasses global indexes of companies in their respective sectors (Gas, Water & Multi-Utilities; Pipelines; and Railroads) and is compiled by Refinitiv Datastream. The Dow Jones Brookfield Global Infrastructure Index is a float- adjusted market-capitalization-weighted index that measures performance of globally domiciled companies that derive more than 70% of their cash flows from infrastructure lines of business. Resource equities: 50/50 Blend of Datastream World Oil & Gas and Datastream World Basic Materials through 5/31/08; S&P Global Natural Resources Index thereafter. The Datastream World Index Series encompasses global indexes of companies in their respective sectors (Datastream World Oil & Gas and Datastream World Basic Materials) compiled by Refinitiv Datastream. The S&P Global Natural Resources Index includes 90 of the largest publicly traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified, liquid and investable equity exposure across three primary commodity-related sectors: Agribusiness, Energy and Metals & Mining. Short-duration fixed income: The ICE BofA 1–3 Year U.S. Corporate Index tracks the performance of USD-denominated investment-grade corporate debt publicly issued in the U.S. domestic market with a remaining term to maturity of less than 3 years. Gold: Gold spot price in USD per Troy ounce. Global stocks: MSCI World Index, a market-capitalization-weighted index consisting of a wide selection of stocks traded in 24 developed markets. U.S. bonds: The ICE BofA U.S. Treasury 7-10 Year Bond Index measures the performance of public obligations of the U.S. Treasury that have a remaining maturity of greater than 7 years and less than or equal to 10 years.
A real assets strategy is subject to the risk that its asset allocations may not achieve the desired risk-return characteristic, underperform other similar investment strategies or cause an investor to lose money. The risks of investing in REITs are similar to those associated with direct investments in real estate securities. Property values may fall due to increasing vacancies, declining rents resulting from economic, legal, tax, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions. An investment in commodity-linked derivative instruments may be subject to greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Among the risks presented are market risk, credit risk, counterparty risk, leverage risk and liquidity risk. The use of derivatives can lead to losses because of adverse movements in the price or value of the underlying asset, index or rate, which may be magnified by certain features of the derivatives.
The market value of securities of natural resource companies may be affected by numerous factors, including events occurring in nature, inflationary pressures and international politics. Global infrastructure securities may be subject to regulation by various governmental authorities, such as rates charged to customers, operational or other mishaps, tariffs and changes in tax laws, regulatory policies and accounting standards. Foreign securities involve special risks, including currency fluctuation and lower liquidity. Because the strategy invests significantly in natural resource companies, there is the risk that the strategy will perform poorly during a downturn in the natural resource sector. The Fund must meet certain diversification requirements under the U.S. tax laws. No representation or warranty is made as to the eﬃcacy of any particular strategy or fund or the actual returns that may be achieved.
Futures Trading Is Volatile, Highly Leveraged and May Be Illiquid. Investments in commodity futures contracts and options on commodity futures contracts have a high degree of price variability and are subject to rapid and substantial price changes. Such investments could incur significant losses. There can be no assurance that the options strategy will be successful. The use of options on commodity futures contracts is to enhance risk-adjusted total returns. The use of options, however, may not provide any, or only partial, protection for market declines. The return performance of the commodity futures contracts may not parallel the performance of the commodities or indexes that serve as the basis for the options it buys or sells; this basis risk may reduce overall returns.
Cohen & Steers Capital Management, Inc. (Cohen & Steers) is a registered investment advisory firm that provides investment management services to corporate retirement, public and union retirement plans, endowments, foundations and mutual funds. Cohen & Steers U.S. registered open-end funds are distributed by Cohen & Steers Securities, LLC and are only available to U.S. residents.