As investors struggle to balance long-term objectives with short-term market moves, one trend has been a gradual but clear shift toward bringing more exposure to real assets such as real estate, timber and farmland into their portfolios.
This change in strategy is challenging the traditional foundation of equities and bonds within pension fund and private investor portfolios. Fixed-income assets offer meager yields and increasingly bear comparably higher interest rate and duration risk. As for equities, their upside potential remains constrained in many markets by modest economic growth, full pricing and heightened volatility.
Research has shown that increasing exposure to a range of real assets by as little as 5 percent can have a significant impact on a portfolio by reducing volatility and potentially increasing returns. Real assets can generate yields that are competitive with other fixed-income alternatives and exhibit long-term stability. Also, for many investors, an attraction of real assets is their protection against inflation. Given the low yields on government and corporate bonds, fixed-income assets are particularly vulnerable to inflation. Rising rates in some developed countries - coupled with diminished equity returns going forward (projected to be less than 7 percent in developed markets) - have investors taking a closer look at nontraditional asset classes.
Investing in real estate means that investors will need to become comfortable with the less liquid nature of these asset classes. This illiquidity often translates into a return premium, however. In addition, given the local nature of real assets, different real asset categories generally have low correlations both with the public financial markets and with one another and have the ability to match up well with the long-term liabilities of many institutional portfolios.
Some material excerpted from Bernie McNamara January, 2015