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Asset allocation

Optimizing outcomes through alternatives:
Real assets

Justin "Biff" Ourso
Senior Managing Director, Head of Nuveen Real Assets
Aerial view of colorful fields with an overlay of author Biff Ourso

Real assets

Real assets, including farmland, timberland and private equity infrastructure investments, historically have generated relatively attractive and stable levels of current income.

Much of this income is driven from contractual payments, such as acreage leased to farmers and infrastructure assets with long-term contracts for providing essential services, as well as from the ongoing production and sale of commodities in the case of farmland and timberland investing.

The risk factors that drive the value of these assets are highly idiosyncratic, as they are tied to different types of crops, operating structures, contractual agreements, geographies and other factors that vary from asset to asset. This diversification of income streams leads to extremely limited correlation across assets and relative to other asset classes.

Real assets have low correlations to other asset classes — and to each other

Considerations for risk factor-based investing

Essential services drive income security
At their core, real assets have proven to be exceptional stores of value and defensive income generators because they provide products or services that are essential to the global economy. The reliability of real assets was on display throughout the Global Financial Crisis, and the current coronavirus pandemic highlights the noncyclicality of food consumption. Within infrastructure, certain types of usage-based assets, such as parking garages, toll roads and ports, are more closely tied to economic activity. But these exposures can be offset by investing in availability-based assets, contracted power production or digital infrastructure (e.g., cell towers and data centers) that have proven resiliency.

Multiple levers for customizing risk exposure 
Real assets allow investors to combine a macro view of global growth drivers (i.e., megatrends) with a localized assessment of individual assets and investment vehicles. Investors can use various operating strategies to dial up or down the risk factors affecting the security of real assets’ cash flows. In farmland, for example, cash-leasing to a third-party farmer is a lower-risk, lower-value-add relationship; the investor essentially is taking on modest credit risk. On the other end of the spectrum, farmland investors can take on operating risk, in which case management expertise becomes critically important due to the many levers that can be pulled around maximizing crop yield, navigating futures markets and crop marketing, and managing weather-related risks.

Hedging more than just inflation 
Commodity prices naturally serve as a hedge against inflation, while infrastructure investments are often defined by long-term contracts that include an inflationary adjustment, protecting the value of long-term cash flows. A globally diversified real assets portfolio also provides powerful natural hedges against factors that are increasingly relevant in today’s interconnected global economy. If droughts in Australia cause a supply shortage in the region, for example, an investor who owns farm assets in South America may benefit from rising prices. A globally diversified portfolio can also provide a hedge against changing trade relationships as well as idiosyncratic political and regulatory risks in a country.

Real asset returns have significantly outpaced inflation 

Technology and management can unlock productivity 
Technological advancements and productivity improvements are differentiated drivers supporting the enhanced income profiles of real assets. In farmland, these improvements could be related to seed hybrids, GPS-enabled equipment and “smart” irrigation systems that boost crop yields and enhance the value of the land. In infrastructure, improvements can include enhancing the operating efficiency of assets through scale, cost reductions or capital improvement programs. The unique value-add capabilities of management often facilitate and enhance the earnings stream of real assets through these improvements.

Biological growth in timber provides uncorrelated returns  
The commercial volume of timber increases naturally as trees convert sunlight, water and carbon dioxide into wood. Because the steady increase in commercial timber volume isn’t affected by market volatility or business cycles, tree growth provides a source of uncorrelated return. The ability to store timber “on the stump,” or delay harvesting when prices are unfavorable, may help buffer returns during down markets and optimize income over the long term.

A differentiated way to invest in structural growth drivers 
As previously noted, infrastructure investors seeking increased exposure to economic activity can choose more volume- or usage-based assets, whereas investors seeking insulation from GDP cycles can favor availability-based assets. In addition, investors can use infrastructure to focus on long-term structural growth trends of the economy, such as investing in digital infrastructure assets, which have seen increased use during the coronavirus pandemic and were already expected to see continued demand growth with the rollout of 5G technology.

Figure 7: Idiosyncratic return drivers in real assets 

COVID-19 impact: Resiliency of farmland and availability-based assets on display

The coronavirus crisis is affecting various real assets in different ways, reflecting the nuanced risk factors that drive returns in this asset class. These differences highlight the importance of diversification, active management and careful structuring and positioning in the capital stack when investing in real assets.

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Dimitri Stathopoulos
United States

All market and economic data from Bloomberg, FactSet and Morningstar. 

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, or liability for, decisions based on such information, and it should not be relied on as such. 

A word on risk 

All investments carry a certain degree of risk, and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. In portfolios that include lower-rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Socially Responsible Investments are subject to Social Criteria Risk, namely the risk that because social criteria exclude securities of certain issuers for nonfinancial reasons, investors may forgo some market opportunities available to those that don’t use these criteria. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not suitable for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy. 

Nuveen provides investment advisory services through its investment specialists.