Accessing real assets with closed-end funds

You already benefit from real assets in everyday life, from the toll roads you drive on to the cell towers that carry your calls. What you may not realize is that these types of real assets also offer investors the opportunity for diversification, inflation hedging and competitive total return potential. What’s more, they can serve as a nontraditional source of income. Investing directly in real assets, however, can be difficult for the average investor, which is why many choose to access the sector through funds that invest in real assets. Closed-end funds (CEFs) not only provide access to the opportunities real assets provide, they also offer the potential for attractive regular income, something many investors are seeking in the low-yield environment.

Why real assets?

Real assets typically include real estate such as land and commercial properties as well as real estate investment trusts (REITs), infrastructure such as toll roads, pipelines, airports and cell phone towers, and commodities such as oil, natural gas, precious metals, corn and soybeans. While each of these types of assets are quite distinct, they have certain features in common, including potential diversification benefits due to their relatively low historical correlation to more traditional investments such as stocks and bonds. In addition, real assets can also help diversify portfolios by offering opportunities across geographic regions and capital structures — from traditional equity to preferred shares to debt.

Real assets have also historically shown a positive correlation to inflation, meaning their values or prices have tended to rise as inflation increases with economic expansion. Therefore, while real assets can be vulnerable to economic downtowns, during inflationary periods they may help reduce the negative impact of inflation and rising interest rates on a fixed-income portfolio. They may also provide competitive total return and, in the case of infrastructure and real estate, have the potential to produce attractive yields because these assets typically garner a fee for use and have a consistent income stream (e.g., lease income on an apartment building).

Why Closed-End Funds?

CEFs that invest in real assets provide access to these opportunities plus the potential for higher regular income than other more traditional types of investment vehicles may offer. This is due to their unique structure and, often, their use of leverage. Because a CEF trades on an exchange after its initial public offering (IPO), investors looking to buy or sell shares do so via the exchange rather than transacting with the fund’s sponsor. This means that the fund’s managers don’t have to keep cash on hand or sell holdings at an inopportune time to accommodate shareholder redemptions. Therefore, the fund can remain more fully invested and invest in less liquid investments that may offer more attractive longer-term returns.

The use of leverage is also designed to enhance a CEF’s income and return. While there are different ways a fund can leverage itself, investing with leverage largely entails the fund borrowing at lower short-term rates and investing the proceeds in longer-term securities with higher rates of return, increasing the fund’s investment exposure and potentially its income and return. It’s important to note that leverage typically magnifies a CEF’s performance, whether positive or negative, but over longer periods of time, the net effect of leverage has generally been positive.

Most CEFs use leverage and are actively managed by professionals who closely manage the leverage strategy and the fund’s distributions, with a goal of providing shareholders high regular monthly or quarterly distributions, regardless of what securities the fund invests in.

Beyond their potential for attractive regular distributions, CEFs that invest in real assets provide access to real asset securities that might otherwise be unavailable to individual investors. This, coupled with the potential diversification and inflation hedging benefits of the asset class, makes an allocation to real asset CEFs worth consideration for income-seeking investors.