Real asset allocations have been gaining traction among investors who are looking to diversify beyond traditional stock and bond portfolios. A growing number of institutions and consultants have carved out a distinct bucket of real assets as part of their long-term strategic asset allocation policies. Although this growth suggests that real asset allocations are becoming better understood, a survey by Greenwich Associates released earlier this month reveals some lingering investor misperceptions about listed and private real asset investments.
We were surprised by one of the survey’s findings in particular: Institutions were more likely to count illiquid, private market strategies, rather than fully liquid real assets, as real assets. In our view, however, given the fundamental characteristics and attributes that listed and private categories have in common, the extent of institutional reliance on ownership structure to drive allocation decisions doesn’t seem justified.
First and foremost, backing every investment in private and listed real assets are hard, tangible assets. At the same time, the public and private market counterparts that make up each real asset category have many economic sensitivities in common that complement each other and serve as valuable portfolio diversifiers. Investors would be better served by focusing more on the fundamentals of real assets and less on their varied ownership structures. (We at Cohen & Steers take a deeper dive into this argument in our recent white paper “What’s Real Is Real.”)
Our research examined core real asset categories in the context of three commonsense investment criteria: meaningful diversification benefits to a portfolio concentrated in stocks and bonds, the potential to deliver attractive returns over a full market cycle and the expectation of showing higher sensitivity than stocks and bonds to unexpected inflation. For the most part, real assets scored favorably on each of the above criteria, both as stand-alone allocations and — more reliably — when combined in a diversified multiasset class framework.
By comparing the long-term performance of various asset classes during periods in which stocks and bonds have underperformed, the diversification potential of real assets becomes evident. Since the early 1990s, such market conditions on average have generated moderately positive returns for both stocks and bonds. But taking a more extensive look back, beginning with the inception of index data in the early 1970s, these periods of joint stock and bond underperformance delivered negative inflation-adjusted returns. In contrast, listed real asset categories — real estate, commodities, natural resource equities and infrastructure — outperformed stocks and bonds while delivering positive real returns. The major categories of private real assets — private real estate, private infrastructure, timberland and farmland — similarly showed strong performance under these conditions.
In terms of maximizing the efficiency of the overall real assets allocation, we generally advocate for a balanced approach to listed and private real assets. Of course, some investors may have reasons to tilt one way or the other. Because private investments are not valued daily, a common perception is that they are not particularly risky. We need only to point to the dearth of liquidity in the aftermath of the 2008–’09 financial crisis to dispel this myth. Moreover, measurement biases are a well-known problem with private market investments. Such distortions should be considered carefully when building a long-term allocation strategy.
Overall, we see far more similarities than differences in the potential for both listed and private real assets to diversify a portfolio of stocks and bonds, improve overall portfolio efficiency and boost risk-adjusted returns. The notion that real assets are somehow made more real by virtue of a private ownership structure calls to mind an old riddle often attributed to Abraham Lincoln: How many legs does a dog have if you call the tail a leg? Answer: Four. Calling a tail a leg doesn’t make it a leg. Investors can no more alter the underlying economics of real asset investments by changing the ownership vehicle than we can alter the canine leg count by arbitrarily relabeling appendages.
Vince Childers, CFA, senior vice president, is a portfolio manager for the real assets strategy at Cohen & Steers in New York.
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