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Putting real assets to work supporting insurance products
Improving the risk/return profile of a conservative fixed-income portfolioCalifornia vineyards, U.S. Pacific Northwest timberland and New York City commercial real estate might not come to mind as potential holdings of a conservative insurance portfolio. But private real asset investments like these represent a small but growing portion of the TIAA General Account, supplementing investments largely in high-quality bonds.
Why would relatively illiquid alternative investments make sense for a statutory portfolio with about two-thirds of its assets in low-risk, fixed-income investments supporting contractually guaranteed payments? The answer lies in the powerful diversification and inflation hedging potential of private real assets that can help to reduce overall portfolio risk. Direct investments in real assets represent $17.9 billion, or about 7%, of the $271 billion General Account (see figure).
Real assets provide three potential benefits to the General Account: current income, long-term capital appreciation, and low correlations with traditional investments.
- Income generation: While most traditional fixed-income investments recently have offered low yields, real assets have generated relatively attractive and stable levels of current income. Expected annual income returns range from about 3% to 6%, depending on asset category. Mainly, this income comes from leases — acreage leased to farmers, commercial real estate rented to tenants, timber sales and infrastructure leased to municipalities or agencies.
- Capital appreciation: Expectations of the increasing value of land and natural resources over time act as a hedge against inflation — protecting the General Account’s future purchasing power. Projected annual total returns range from 7% to 10%, depending on asset category.
- Low correlations: Real assets tend not to move in lockstep with traditional investments. Their correlations to stocks and bonds are low and sometimes negative, providing diversification that is especially desirable when correlations between traditional assets converge during periods of market volatility.
Advantages of private real assets over publicly traded commodity stocksIn seeking to diversify the General Account, TIAA chose direct investments in real assets over publicly traded commodity stocks for important reasons. Real assets tend to be much less volatile because they are not subject to market speculation, such as options trading. At times when the commodity price cycle is unfavorable, we have flexibility to leave real assets in the ground to await better prices. Unlike bonds that mature or may be called, we can hold real assets indefinitely, selling appreciated property as needed to help meet the General Account’s long-term liabilities.
Managing risks inherent in real assetsTIAA has developed solutions to address illiquidity and other risks inherent in holding real assets. The General Account holds appropriate amounts of liquid assets and other liquidity sources. Real assets investments can be structured in ways that reduce exposure to operational risks, such as growing, harvesting and selling crops or timber. In many cases, Nuveen can avoid these risks by leasing farmland or creating wood supply agreements with local mills.
Diversification across global regions and asset types helps to address other risks. Agricultural investments, for example, are spread across four continents — Australia, North and South America, and Europe — reducing exposure to drought, pest damage, commodity pricing and other market-specific risks. In real estate, the size and scope of the U.S. market provide ample geographical diversification across regions and metropolitan areas, along with property-type diversification. Nuveen Real Estate has offices across the globe providing opportunities to diversify in the U.S., Europe and Asia.
Across its range of real asset management capabilities, Nuveen has embedded responsible investment practices, adding a further layer of risk management for environmental, social and governance concerns. With real assets investment experience dating to 1934 in real estate, 1998 in timber, and 2007 in agriculture, Nuveen has a first-mover advantage in establishing scale and developing expertise ahead of most other asset managers.
Real asset exposure in the TIAA General Account already provides important contributions to risk-adjusted returns. In continuing efforts to diversify the portfolio and hedge inflation, TIAA expects to maintain healthy allocations to farmland, infrastructure, real estate and timberland. Investments in real assets offer the potential to combine steady current income and long-term capital appreciation, making them a good fit with the General Account’s current and long-term liabilities.
Figure: Allocations to real assets in the TIAA General Account (as of 31 Mar 2020)
Investments in real assets offer the potential to combine steady current income and long-term capital appreciation, making them a good fit with the GA’s current and long-term liabilities.