An allocation of tangible assets like real estate and infrastructure can provide positive diversification for a traditional stock and bond portfolio during uncertain times.
The geopolitical and economic landscape today is highly unstable. After years of extraordinarily low interest rates and fears of deflation, policymakers are now facing the effects of inflation and slowing growth. In a recent speech, US Federal Reserve Bank Chairman Jerome Powell signalled that inflation would be a primary driver of US central bank policy going forward.
For investors, it can be challenging to protect and grow wealth in such an uncertain economic environment. However, investing in real assets is a useful strategy that can provide stability and diversification when growth expectations have slowed, and the risk of inflation has risen.
The real assets category of investments is extensive, encompassing real estate, infrastructure, commodities, and to some extent natural resources. What these diverse assets have in common is that they are real, tangible, and measurable.
Real assets are the raw materials and structures that facilitate economic growth by forming the foundations of value chains, and building the backbone of society. They are fundamental to the economy and often have unique investment characteristics. For example, real estate and infrastructure companies often offer domestically focused business models with stable cash flows, making them less dependent on international trade in the short term.
This can be especially valuable in inflationary periods, like the last three years. For example, the price of commodities is often highly sensitive to inflation, as the rising cost of goods and services is directly reflected in prices. In addition, the income generated by infrastructure and real estate is typically directly or indirectly linked to inflation.
Not every investor buys a building or a barrel of oil.
That said, it isn't always either wise or possible for investors to gain direct exposure to real assets, for example, by buying a building or a barrel of oil. But among the real assets investors can use exchange traded/liquid instruments like for example listed real estate companies, known as REITs (real estate investment trusts), which own and operate income-producing properties. Examples include: data centres, the growth of which is driven by the rise of AI (artificial intelligence) and cloud computing; senior housing, where demand is fuelled by the aging baby boomer population; and single-family rental properties, which meet the needs of millennials.
Listed infrastructure companies offer exposure to the resources and services that are essential to the daily functioning of our society and economy. For instance, these companies build and manage the infrastructure that ensures we receive the utilities required for daily life: water, energy, transportation, and telecommunications.
While some sectors within infrastructure are sensitive to trade and global demand, these companies generally offer predictable revenue streams, driven by long-term contracts. This makes the asset class more resilient and defensive than a broader equity portfolio.
Commodities and natural resource equities share some characteristics. Commodities are the raw materials that provide direct exposure to resources such as oil, gas, soybeans, wheat, copper, and gold. Natural resource equities offer ownership of companies that extract, produce, and distribute these commodities. Both these sectors, when combined thoughtfully with real asset classes, have outperformed when inflation is high, regardless of whether the inflation stems from higher or slower growth, but especially when inflation surprises on the upside.
The four areas that we identify as real assets: real estate, infrastructure, commodities, and natural resource equities, offer another important benefit. This is that they each behave differently, delivering growth in capital - or dividends - at different times. While each sector on its own can provide too much volatility, the inclusion of an allocation to each of the four segments of real assets in a portfolio has historically delivered competitive returns with lower fluctuations than global stocks.
It's interesting to note that historical data from 1978 to 2024 also shows that a portfolio that combined global stocks, US bonds, and real assets provided more protection against downside losses in a variety of economic scenarios than a simple global stock and US bond portfolio. Of course, past performance is no guarantee of future returns.
Against the current backdrop of downside risks to growth and upside risks to inflation, the diversification value of real assets deserves closer attention from investors interested in pursuing a more balanced and resilient portfolio. We believe that over the long term, including real assets can help to build resilient, truly diversified portfolios that can withstand different market environments.
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