Real assets are physical, tangible investments—such as real estate, precious metals, timber, and infrastructure—that historically have tended to maintain their real value independent of currency fluctuations. These types of assets are generally far upstream in a value chain and close to the primary or raw material stage.

When inflation is present, producers of raw materials typically have been able to manage inflation better than companies that are closer to consumers in the value chain. Hence, during inflationary periods, real assets can serve as a source of security and a store of value when many traditional equities may see their input costs rise and margins decline.

The following discussion provides descriptions of some of the most common real assets and their characteristics, along with ways you can invest in them.

Commodities

Commodities are raw materials (e.g., copper or gold) that can be bought and sold. Commodities can function as an inflation hedge and provide real return because they are a tangible asset and often priced in U.S. dollars. The risk/return profile of commodities is affected by the supply and demand dynamics of each individual commodity as well as U.S. dollar movements.

Commodity prices are often positively correlated with inflation because many commodities are used as inputs to produce goods and services. In addition, some commodities are components of inflation measures. For instance, the Consumer Price Index (CPI) includes the price changes of gasoline (a refined product derived from crude oil) in its computations; therefore, an increase in gasoline prices could directly contribute to an increase in inflation.

Precious Metals

Four precious metals are commonly considered for investment purposes:

• gold,
• silver,
• platinum, and
• palladium.

In addition to its extensive use in jewelry, gold has established itself historically as a safe haven from inflation, currency devaluation, and political and economic disruptions.

As hard assets that can also protect against inflation, the remaining three precious metals are driven by industrial activity and demand. Silver, for example, has traditionally been used in photography and silverware and is now being used in solar panels and televisions. Platinum and palladium are used in automobile catalytic converters, so their price is affected by car demand.

Energy Commodities

Energy commodities can also provide investors with an inflation hedge because these basic inputs are critical to economic activity, such as transportation and construction.

Ways to Invest

Commodity mutual funds offer investors exposure to futures-based commodity indices, such as the Bloomberg Commodity Index, which is a diversified index that caps the weights for commodity subsectors, such as energy or precious metals. The Bloomberg Commodity Index is generally weighted about one-third agriculture, one-third energy, and one-third metals.

Commodity mutual funds use swaps and futures to gain commodity index exposure, with fixed-income instruments as collateral. Commodity mutual funds may have difficulty tracking the spot prices of commodities (i.e., the price at which commodities can be bought and sold at a specific time) over time because they use commodity contracts, which must be rolled forward periodically when the contracts are about to expire, creating a gain or loss in addition to the spot return. Some commodity mutual funds keep the same commodity weighting as their benchmarks, while others choose to overweight or underweight certain commodities relative to the benchmark.

Unlike commodity mutual funds, natural resource mutual funds offer commodity exposure through companies (i.e., equities) that engage in the production of commodities. This indirect exposure means that, though these funds are vulnerable to the ebbs and flows of equity markets, they are not subject to the complication of attempting to track commodity spot prices using futures, swaps, or other derivatives. Natural resource mutual funds can provide a leveraged position to the spot price of the underlying commodities.

Although natural resource mutual funds may not be as correlated historically to the price of the underlying commodities, they do have the ability to make managerial decisions—such as hedging, changing capital expenditure plans, and cost control—that can help mitigate a poor commodity market or enhance a good one.

Exchange-traded products exist in futures and equity formats and, in many cases, offer more targeted strategies, including many commodity-specific options, than mutual funds. For precious metals, there are exchange-traded funds (ETFs) that buy and hold the physical metal in vaults. This type of investment gives investors results closest to the commodity’s spot return.

Commercial Real Estate

Commercial real estate includes places people sleep (apartments and hotels), work (office buildings), and shop (retail buildings), as well as properties that support consumer-facing activities (industrial buildings and distribution centers). Only a couple of decades ago, investment in commercial real estate was restricted to very wealthy individuals, pension funds, endowments, and the like. Securitization has allowed investors to pool their money to invest in properties.

Commercial real estate investment returns generally come from two main sources: income and capital appreciation. Income return is derived from the ongoing operations of the property or portfolio of properties. In most cases, the commercial property owners are collecting rents (revenue) and paying out financing and operating costs (expenses). The difference between the revenues and expenses may be passed on to the property owner in the form of an ongoing income yield.

Capital appreciation is measured as the difference between initial investment and amount returned when an investment is sold. The ultimate outcome can be affected by property-specific factors (e.g., change in the property’s occupancy rate), location factors (e.g., new supply entering the market as the result of development), and/or macroeconomic factors (e.g., market capitalization rate changes due to a perceived change in the risk environment). 

Real estate has tended to be cyclical, but many view commercial real estate as an inflation hedge for these reasons:

1.  As the price of goods and services rises, so may the rental rates that property owners can charge tenants.
2. Replacement cost is a significant factor in determining when new development occurs. As construction and material costs increase due to inflation, existing properties may also rise in value before additional competitive supply is added to the market.
3. Due to commercial real estate’s high percentage of capital or fixed assets, inflationary pressures (which tend to affect variable inputs like labor costs) tend to have a limited effect on the expense side of a real estate portfolio’s income statement.

Like most investments, there are a number of nuances that affect the risk/return profile of a commercial real estate investment, including location, lease structure, tenant quality, and financing strategy. To reflect risk levels, commercial real estate investments are often grouped in one of four categories:

1. Core properties tend to be lower risk/return vehicles. They are characterized by low vacancy, long-term leases to creditworthy tenants, and strong locations. An investor purchases core real estate to seek income.
2. Core-plus properties are further out on the risk/return spectrum than core properties. These properties are mostly stable but have some factors that increase risk. An investor purchases core-plus real estate to seek income; capital appreciation is a secondary objective.
3. Value-add real estate takes us one step further on the risk/return spectrum. These properties tend to require a repositioning effort. An investor purchases value-add real estate to seek capital appreciation; income is a secondary consideration.
4. Opportunistic real estate is the most aggressive of the existing property types. These properties require a major repositioning effort and may contain other extenuating circumstances. An investor purchases opportunistic real estate to seek capital appreciation.

Lease terms can also be a key factor because lease durations vary across property types. Property types with shorter lease durations (e.g., hotels and apartments), for example, can increase rents more frequently to keep up with inflation. On the other end of the lease duration spectrum, properties with triple net leases tend to have more limited pricing power due to the longer-term leases.

Ways to Invest

Because of the scale of the investment, commercial real estate is usually a more viable investment option for those investing in a securitized or fund format. Publicly traded real estate investment trusts (REITs), REIT ETFs, and REIT mutual funds offer investors exposure to a portfolio of properties that is typically regionally diverse and possibly sector diverse, too. These investment vehicles are transparent, liquid, and cost-effective, but have the potential for a risk profile similar to the broader equity market.

Nontraded investment vehicles — interval funds, nontraded REITs, and real estate–focused limited partnerships—do not enjoy the liquidity of traded REITs, typically have minimum holding periods, and may have inefficient fee structures, but they aren’t subject to the daily emotion of the markets and may have higher distribution rates. 

Infrastructure

Infrastructure refers to systems that move people and distribute critical goods, as well as to essential facilities and services. The term typically refers to the technical structures that support a society, such as roads, water supply, sewers, power grids, and telecommunications. Although many of the services in this domain have long been provided by the government, public budget shortfalls and rapid expansion have created opportunities for private sector investment and profit.

Not all infrastructure investments share the same characteristics. Assets such as toll roads, ports, and airports tend to be cyclical, whereas others, such as utilities, tend to offer more stable cash flows and current income. Some assets are leased under terms that allow for increases as the CPI rises. This feature, in addition to their quality as hard assets, can provide investors with protection against measured inflation.

Ways to Invest

Infrastructure mutual funds and ETFs provide exposure to a global universe of publicly traded infrastructure companies that own, operate, and develop infrastructure assets.

Timberland

Timberland investing refers to ownership of land with harvestable lumber, taking the form of tree farms or managed natural forests. Timber provides investors with income when trees are harvested and sold, along with potential capital appreciation as the value of the land increases. Timber value depends, to a certain extent, on the demand for wood, which, in turn, is driven by measures such as new home construction.

One advantage of timber is that trees grow naturally and require little maintenance, so owners can choose the optimal time to harvest and sell. The trees and land provide a natural hedge against inflation. Timberland owners also have the option to develop or repurpose land if doing so will increase value.

Ways to Invest

Timber REITs provide exposure to the ownership and management of timberlands. A portion of some timber REITs’ revenues, however, may be based on downstream activities, such as wood and paper processing and production.

Diversified Real Assets Funds

Mutual funds and ETFs are available for diversification across real assets that encompass commodities, infrastructure and natural resources companies, and traded REITs.

Key Takeaways

Real assets run the gamut from naturally occurring resources, to items that are grown and harvested, to structures and land. The common element that links them is their potential ability to offset some of the effects of inflation. In general, a hard asset will maintain its intrinsic, real value in the face of increasing currency supplies and potential devaluations, thus preserving investors’ purchasing power.

Contact Us

If you are interested in further exploring the world of real assets, please contact us so we can help you determine their role in your portfolio. 

Johnathon Opet, CFP® is a financial advisor located at EmVision Capital Advisors, 251 W. Garfield Rd. ​Suite 155 Aurora, OH 44202. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network^®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at (330) 954-3770 or at info@emvisioncapital.com.

Disclosure: 
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Please contact your financial professional for more information specific to your situation.

Investing in natural resources investments can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments and the cost assumed by companies in complying with environmental, political, and safety regulations. Investing in physical commodities, such as gold, exposes these funds to other risk considerations such as potentially severe price fluctuations over short periods of time.

These funds use investment techniques with unique risks, such as merger arbitrage risks, high portfolio turnover risks, options risks, borrowing risks, short sale risks, nondiversification risks, liquidity risks, and foreign investment risks, which may increase volatility and may increase costs and lower performance. There is no assurance that these funds or any investment will achieve their investment objectives. A nontraded real estate investment trust (REIT) is a REIT that is not traded on any public stock exchange. Nontraded REITs are generally illiquid securities for which no public market exists. As such, investors may be unable to liquidate the security at any price. 

You should consult with your financial advisor and carefully consider your short-term and long-term liquidity needs. Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply or demand; competing properties in an area; changes in interest rates; and changes in tax, real estate, environmental, or zoning laws and regulations. Real estate units/shares fluctuate in value and may be redeemed for more or less than the original amount invested. There is no assurance that the investment objective will be attained.

All indices are unmanaged and investors cannot invest directly in an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results. The Consumer Price Index (CPI) is an index estimating the average price of consumer goods and services purchased by households, as measured by the price change for a constant market basket of goods and services from one period to the next within the same area. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Bloomberg Commodity Index and subindices are composed of futures contracts on physical commodities commonly used to measure the price of commodities.

Exchange-traded funds (ETFs) are subject to market volatility, including the risks of their underlying investments. They are not individually redeemable from the fund and are bought and sold at the current market price, which may be above or below their net 
asset value.

Authored by Nathan Parker, CFA®, CAIA, senior investment research analyst, and Chad LaFauci, CFA®, vice president, alternative investments, at Commonwealth Financial Network®.