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Income Investing

Get real with income-producing real assets

Matthew J. Weyandt
Client Portfolio Manager
Get real with income

We have seen demand for real assets grow dramatically in recent years, and we expect it will advance further as investors better understand the positive attributes of the asset class. Real assets offer the opportunity for diversification, inflation hedging and competitive total return potential. Real assets may also serve as a nontraditional source of income, a feature that investors frequently overlook.

What are real assets?

Broadly, real assets provide the framework and resources to facilitate everyday activity in the world economy. While numerous types of investments could be considered real assets, our definition includes:

Unlike conventional stocks and bonds, the value of listed real asset investments comes from the physical nature of their underlying assets. This direct link to hard assets means real assets often store long-term value better than more traditional investments. Their intrinsic value may also increase due to higher utilization, greater demand or scarcity of supply.

The inherent characteristics of each real asset can vary, but they have several features in common.

Diversification benefits

Real assets have historically exhibited a lower correlation to a wide variety of investment alternatives, as well as other real assets. The performance drivers for real assets are fundamentally diverse from other types of securities. By expanding into asset classes with lower correlations, investors may potentially benefit from greater diversification.

Real assets 

Inflation hedging ability

Real assets have historically exhibited greater ability to hedge inflation than the broader equity and fixed income markets. Real assets have generally offered stronger returns during periods when inflation is rising.

Real assets offered 

In general, inflation increases as economic activity accelerates. In such an environment, commodity prices tend to rise in conjunction with inflation, as demand for goods increases with gains in consumption and building activity. Infrastructure and real estate also tend to have a positive correlation with inflation. When the prices for goods and labor costs increase, the replacement costs for these types of assets also increase. Additionally, many infrastructure assets have a direct tie to inflation measures such as the Consumer Price Index (CPI) in their contracts or concessions.

Real estate companies often structure leases with rent escalators that increase the rent over the life of the lease. In both cases, these structures are used to grow cash flows in an attempt to account for the potential effects of inflation.

Competitive total return potential

Infrastructure investments have outpaced most other equity groups, including U.S. stocks and non-U.S. stocks, since 2002. Global real estate has exhibited a similarly strong return profile over the period.

Infrastructure and real estate 

In addition, infrastructure has also offered a higher return with similar or less risk. And while global real estate has demonstrated more risk than broader domestic and international equities, it has provided more return per unit of risk than each of those groups.

Infrastructure offers 
Infrastructure and global 

Overall, infrastructure and global real estate equities have provided stronger riskadjusted returns than both domestic and international equities.

Commodity returns since 2002 are low, as the asset class has been in a bear market that has persisted since the financial crisis in part due to supply and demand imbalances.

Nontraditional source of income

We believe real asset investments that offer a stable yield supported by contractual cash flows are especially attractive. These investments have assets that tend to be monopolistic, providing a strong and consistent income stream usually derived from their fee-for-use nature.

Infrastructure and real estate exemplify these types of income-producing real assets. These companies commonly own or operate location-specific hard assets that garner a fee for use through long-term contracts, concessions or leases. Commodities rely solely on capital appreciation and offer no income component. Infrastructure and real estate have the potential to produce attractive yields compared to other commonly held investments.

These alternative income sources may also prove particularly advantageous for investors in low interest rate environments where more traditional yield options are anchored by lower rates, much like we’ve seen globally for the past several years.

Real Estate 

Moreover, these steady income streams may help cushion total returns in times of volatility, potentially providing for added downside risk management.

Emphasizing the most mature companies within infrastructure and real estate with fewer growth expectations allows for stable cash flow, and may result in a less volatile return stream.
Steady income

Consider income producing real assets

Historically, income producing real assets such as infrastructure and real estate have supplied competitive total return and positive inflation hedging effects, with lower correlations to more traditional stocks and bonds. These asset classes have also provided convincing yields, helping investors diversify their income sources. Additional benefits to investors include enhanced total returns and cushioned performance during volatile periods. For these reasons, we feel income-producing assets should be an important part of a balanced portfolio.

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Endnotes

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Glossary
Correlation is a statistical measure of how two securities move in relation to each other. Perfect positive correlation (a correlation co-efficient of +1) implies that as one security moves the other security will move in lockstep, in the same direction. Alternatively, perfect negative correlation (a correlation co-efficient of -1) means that securities will move by an equal amount in the opposite direction. If the correlation is 0, the movements of the securities are said to have no correlation; their movements in relation to one another are completely random.
Downside capture ratio represents the degree to which a strategy outperformed (less than 100%) or underperformed (greater than 100%) the benchmark in periods when the benchmark return was negative. The lower the downside capture ratio, the better. Bloomberg Barclays Emerging Markets Aggregate Index is a hard currency emerging markets debt benchmark that includes fixed and floating-rate U.S. dollar-denominated debt issued from sovereign, quasi-sovereign and corporate emerging markets issuers.
Bloomberg Barclays Global Aggregate Unhedged Index measures the performance of global bonds. It includes government, securitized and corporate sectors and does not hedge currency.
Bloomberg Barclays Municipal Bond Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities.
Bloomberg Barclays U.S. Corporate High Yield Index measures the market of USD-denominated, non-investment grade, fixed-rate, taxable corporate bonds. Securities are classified as high yield if they fall within the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. The index excludes emerging market debt.
FTSE EPRA/NAREIT Developed Index is designed to track the performance of listed real estate companies and REITS worldwide. MSCI Emerging Markets Index is a free float-adjusted market-capitalization-weighted index that is designed to measure equity market performance of emerging markets.
The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
MSCI ACWI Ex US Index is a market-capitalization-weighted index designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. It includes both developed and emerging markets.
S&P 500® Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy.
S&P Global Infrastructure Index is designed to track 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability.
S&P GSCI® Index is a leading measure of general price movements and inflation in the world economy. Sharpe ratio is a measure for calculating risk-adjusted return. Standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility.
U.S. BLS CPI All Urban NSA 1982-1984 is a consumer price index that measures changes in the price level of market basket of consumer goods and services purchased by households.

A word on risk
All investments carry a certain degree of risk, including possible loss principal and there is no assurance that an investment will provide positive performance over any period of time. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager. Concentration in infrastructure-related securities involves sector risk and concentration risk, particularly greater exposure to adverse economic, regulatory, political, legal, liquidity, and tax risks associated with MLPs and REITS. Foreign investments involve additional risks including currency fluctuations and economic and political instability. These risks are magnified in emerging markets. Common stocks are subject to market risk or the risk of decline. Small- and mid-cap stocks are subject to greater price volatility. The use of derivatives involves substantial financial risks and transaction costs. A potential investment in other investment companies means shareholders bear their proportionate share of expenses and indirectly, the expenses of other investment companies. Additionally, infrastructure-related entities may be subject to regulation by various governmental authorities and may also be affected by governmental regulation of rates charged to customers, service interruption and/or legal challenges due to environmental, operational or other mishaps and the imposition of special tariffs and changes in tax laws, regulatory policies and accounting standards.

Nuveen Asset Management, LLC, a registered investment adviser, is an affiliate of Nuveen, LLC.

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