That new apartment complex across the street. The toll bridge you used to get to work. The silver necklace you got your spouse for your anniversary (if you didn’t forget). What do these all have in common? They fall under the broad umbrella of real assets.
Portfolio construction typically begins with the allocation between equities and fixed income, but we believe it shouldn’t end there. Real assets such as infrastructure, real estate, natural resources and commodities provide an opportunity to diversify your portfolio, while current market conditions offer support for the asset class.
Potential benefits of real assets
Historically, real estate, infrastructure and natural resources have enjoyed lower correlations to global stocks than other asset classes (shown in the chart below).
Because of these relatively low correlations, real assets may be combined to offer true diversification in an increasingly interconnected marketplace. This approach can be especially useful during market corrections and downturns.
Infrastructure securities, for example, have outperformed during 15 of the 20 quarters of negative equity market performance since 2001.1 Given the late-cycle nature of the current market environment and the return of volatility, we think these asset classes are worth a second look.
The current market environment has offered support to real assets, as witnessed by strong YTD returns:
Click image to enlarge
Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly. Correlation measures the degree to which two securities move in relation to each other and will show a range of between -1.0 to +1.0. Tax drags: Morningstar category averages – US Fund Natural Resources, US Fund Infrastructure, US Fund Global Real Estate
Sources: Natural Resources: S&P Global Natural Resources, Infrastructure: S&P Global Infrastructure Index, Real Estate: FTSE EPRA Nareit Global Real Estate Index. Global stocks: MSCI World Index. Correlations for the 5 years ending June 30, 2019.
Traditional safe havens such as gold and precious metals have seen positive performance in 2019 and have offered refuge in times of slowing global growth, inflation, or uncertain central bank policy.2
Energy, another key driver of the natural resources and commodity space, has seen a bounce off 2016 lows. Supply cuts have stabilized oil prices, and demand for energy—particularly in emerging markets—remains strong.
Despite minor headwinds including retail spending habits and soft spots in some markets, real estate is buoyed by strong new build numbers and the renewed prospects of low interest rates. While a major infrastructure bill does not appear on the near-term horizon in the United States, global infrastructure spending remains strong and like real estate, it is supported by recent central bank policy.
Higher yields and large amounts of distributed income can increase the potential for tax surprises in real assets. In non-qualified accounts, this drag could result in lower after-tax returns and can compound to reduce portfolio growth over time.
For some underlying real asset sectors, this tax drag can be upwards of 2.5% annually.3Beware of this potential obstacle and opportunities to combat it. Weigh the costs and benefits of diversification and growth against the backdrop of after-tax returns.
Bottom line
The interdependence of markets indicates that investors should look beyond traditional asset classes for diversification. In non-qualified accounts, these benefits should be weighed against potential tax consequences and mitigated when possible. Infrastructure, real estate, natural resources and commodities provide a unique opportunity to access potential differentiated growth, while possibly providing downside protection.
We suggest an allocation to real assets. Current market cycle timing and interest rate movements offer a strong backdrop against which to add real assets to a well-diversified portfolio.
1 Source: S&P Global Infrastructure Index vs MSCI World Index; as of 31 March 2019. Russell Investments calculations.
2 Source of gold and precious metal returns: Morningstar as of June 25, 2019. Gold—HUI Gold Index, precious metals—S&P GSCI Precious Metals.
3 Source: Morningstar Direct, as of March 31, 2019. Morningstar US Fund Real Estate category, 5-year annualized figures.
Disclosures
Real Assets: Investments in infrastructure-related companies have greater exposure to adverse economic, financial, regulatory, and political risks, including, governmental regulations. Global securities may be significantly affected by political or economic conditions and regulatory requirements in a particular country. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risks. Investments in international markets can involve risks of currency fluctuation, political and economic instability, different accounting standards, and foreign taxation.
FTSE EPRA/NAREIT Real Estate Index: The index is designed to measure the stock performance of companies engaged in specific real estate activities of global real estate markets. Relevant real estate activities are defined as the ownership, trading and development of income-producing real estate.
HUI Gold Index: The BUGS Index (HUI) is an index of companies involved in gold-mining. BUGS stands for Basket of Unhedged Gold Stocks. HUI is the ticker symbol for the index. The companies included in the BUGS Index do not hedge their gold production beyond a year and a half, which gives the index substantial exposure to short-term movements in gold prices.
MSCI World Index: A broad global equity index that represents large and mid-cap equity performance across 23 developed markets countries.
The S&P Global Infrastructure Index: Provides liquid and tradable exposure to 75 companies from around the world that represent the listed infrastructure universe. To create diversified exposure across the global listed infrastructure market, the index has balanced weights across three distinct infrastructure clusters: Utilities, Transportation, and Energy.
S&P Global Natural Resources Index: The index includes 90 of the largest publicly-traded companies in natural resources and commodities businesses that meet specific investability requirements, offering investors diversified and investable equity exposure across 3 primary-related sectors: agribusiness, energy, and metals & mining.
S&P GSCI Precious Metals Index: The index provides investors with a reliable and publicly available benchmark for investment performance in the precious metals market.
Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Past performance does not guarantee future performance.
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
This material is not an offer, solicitation or recommendation to purchase any security.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional.
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.
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