Are real assets worth the illiquidity risk for portfolios?
As advisers seek to build well-diversified portfolios to navigate volatility, investment executives say the benefits of real assets can “absolutely” outweigh a lack of liquidity, provided there is a good understanding of its risks and returns.
Appearing on a recent Institute of Managed Account Professionals (IMAP) webinar, a panel of investment experts discussed the benefits and drawbacks of real assets like real estate, infrastructure and renewables.
These assets have grown to become a popular investment choice in recent years amid periods of economic uncertainty and high inflation, despite some concerns of illiquidity as part of an overall investment strategy.
Campbell Ross, head of wholesale at Octopus Investments, said investments in real assets can prove beneficial for a number of reasons.
“Real assets are typically uncorrelated to market movements and that can be incredibly invaluable. If you think about renewable energy assets in particular, the asset characteristics of those, you’ve got a free and forecastable fuel source [of] sun, wind, really attractive revenue profile, and low operating costs,” Ross explained.
From a portfolio allocation perspective, such assets hold a low correlation to other assets while offering a more defensive income, he observed.
“Often, for operational assets, you’ll have long-term, fixed price, inflation-linked purchase agreements with investment-grade counterparties. These assets are a natural inflation hedge as well. So certainly, there’s a lot of benefits in these assets,” he said.
“For me, liquidity is about understanding investor needs, so a good wealth manager or financial adviser will know what their clients need, what’s going to drive value, what’s the value they need over the long-term, and lastly, what are they actually interested in and what excites them.
“Those things are really important and knowing this, they can establish what percentage of a portfolio they can be comfortable putting into more illiquid assets, and of course, it all comes back to diversification.”
Mary Power, principal consultant at JANA Investment Advisers, agreed that investors are “never going to get it right all the time”, highlighting the importance of a well-diversified portfolio that can benefit under various market conditions.
The last few years have particularly demonstrated this with the office sector, Power pointed out, given offices had been a strong performer within the property market for several years prior to the COVID-19 pandemic.
“Obviously, offices have had a difficult time in the last few years globally, as a result of working from home, so if you had 100 per cent in office, you’d have done pretty well for 10 years then you’d hit this difficult point now,” she remarked.
She also noted that well-diversified portfolios that include real assets could prove supportive against equity market risks.
“Unlisted property has given good diversification to equity market risk. As a house, we generally don’t have a lot in REITs but we would say we’re trying to get that whole of portfolio diversification from having some unlisted assets,” she said.
Ultimately, given the risks and potential returns of real assets, “you’ve really got to know what you’re trying to get out of the asset class”, according to Michael Sheffield, head of diversified and infrastructure funds at Dexus.
“The real assets sector is often underpinned by very secure income streams and the volatility often comes around the valuation or the trading,” he said, adding that more traditional assets such as equities could actually prove more volatile.
“The ‘typical’ investments in equities are more volatile as a principle, in that their income stream is not as locked in as it would be in a real estate asset with potentially hundreds of different tenants. So the tenants, by virtue of having lots of them, means they’re diversified,” Sheffield said.
“What I often see in the real asset space is incredibly stable income – not always but often – and that’s a good diversifier in itself. If you’re focused on income, then these asset classes are typically a very good way of getting [that] and they’re very often a very good inflation hedge.”
Sheffield highlighted real assets tend to hold varying risk profiles, resulting in diversification across asset class, sectors, and even geographies.
“Geographies can actually have very different results depending on where your investments are located, and similarly, at a sector level, depending on what sort of investment you’re invested in, that can actually produce very different income streams.
“So you’ve really got to know what you’re trying to get out of the asset class and look at what investments are going to provide the risk/return that you’re after.”
AUTHOR
Rhea Nath
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