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real assets


Optimizing pension plan outcomes using public and private real assets


In a world of low return expectations and even lower interest rates, pension plans are reevaluating their portfolios, looking for alternative ways to achieve return targets and improve funded status.

Diversifying portfolios with real assets helps address these challenges. Real assets may reduce portfolio volatility, enhance returns and generate yield.

However, allocating to real assets is rarely straightforward. Investing in this asset class — whether it is real estate, farmland, timberland, commodities, or infrastructure — is often considered a trade-off between performance and liquidity. We highlight how real asset allocation decisions are more nuanced and complex than this perception suggests and we offer a framework to help with those decisions.


Highlights
  • As well as a rich source of diversification returns, cash flow and inflation protection, real assets can be used to express specific investment views and themes such as impact, sustainable, or natural resource investing. 
  • A factor framework can be blended with the traditional deal-driven approach to optimize real asset portfolios. This hybrid approach reconciles real life investment opportunities with the factor risk framework.
  • Factor analysis helps investors understand the sources of risk and return in a portfolio, revealing insights that help answer the questions "are real assets delivering the expected diversification benefits?" and "are investors getting the exposure they are paying for?"
  • The public pension plan case study illustrates how this framework can be customized for different institutional investors, their specific objectives, constraints, return premium expectations, new and well-established portfolios.

Sources of risk in public pension plans


Exposure to the common factors explains over 99% of the risk in the public pension plan’s portfolio (based on average asset allocation weights for state and local pension plans in the U. S.), and the vast majority of that risk is from equity risk exposure. A real asset portfolio can help diversify risk and offer alternative sources of return.

FIGURE 6: Current portfolio and risk exposures 

Considerations for investing in real assets

We explore three sub asset classes — real estate, farmland and infrastructure — to understand the opportunities real assets offer, the role they can play in a portfolio and the range of choices investors face.

Three ways to build a real asset portfolio

The advantages and disadvantages of different approaches to real asset portfolio construction are outlined including: the traditional deal-driven approach; a factor-driven approach; and a hybrid of those two.

The factors driving real asset returns

With common macro factors driving a substantial proportion of risk in institutional portfolios, we consider how they influence real assets and whether there are specific risks and factor premiums associated with real assets.

A portfolio construction case study

We illustrate how a public pension plan can use this framework to construct a portfolio with explicit factor-exposure targets that aims to maximize the diversification benefits and the return premiums of the real assets.

 

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About the authors

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Dimitri Stathopoulos
United States