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Three ways to build a real asset portfolio
This pragmatic approach focuses on the merits of individual deals. However, it runs the risk of creating random or unintended factor biases in the portfolio.
A factor-based approach overcomes this by developing factor targets before sourcing and investing capital to yield more precise factor exposures. A drawback to this approach is a lengthy implementation process.
We offer a hybrid approach. Its foundation is rigorous factor analysis and targeting, but it is flexible enough to allow opportunistic deal selection. Critical to the execution of this strategy is the use of public real asset strategies in coordination with private investments.
1. The opportunistic deal-driven approach
The private nature of many real assets often means that building a real asset portfolio is driven by deal availability. As general partners raise funds, institutional investors can select the most attractive opportunities for their portfolios.
This opportunistic approach creates a portfolio in which the assets, and as a consequence the risk exposures, are determined by deal flow and by the nature of an investor’s relationships with its real asset partners.
The benefits of being able to react quickly to new opportunities and make tactical commitments for the portfolio could come at the cost of introducing unintended factor biases into the portfolio.
2. The strategic factor-driven approach
Incorporating factor analysis is a more strategic approach to real asset portfolio construction. Portfolio composition is driven by targeting specific factor exposures. Investors determine their optimal factor exposures before committing capital. Opportunities are then sourced to populate factor exposure targets.
These targets are developed as part of the overall portfolio’s asset allocation which should also reduce the risk of unintended factor concentrations. However, the rigidity of this approach will lead to missed opportunities, as investors turn down attractive opportunities that do not fully align with the factor exposure targets.
3. The hybrid approach – implementing allocations in practice
Our proposed approach combines the strengths of the first two approaches. It is a strategic, factor-based approach that is also flexible enough to allow tactical allocations as new investment opportunities arise.
In reality, achieving factor exposure targets or getting close to them is a challenge. Real asset investing depends on the availability of new, attractive opportunities and fund offerings. This is not just the case for private investment structures but also public vehicles that invest in the same or similar underlying assets as private vehicles.
These investment opportunities need to be assessed to determine if they will meet with the investor’s objectives. And should they do so, capital must be available when these opportunities arise.
Focus on explicit factor exposure targets, but be flexible to capitalize on new investment opportunities. Counterbalance risk with a liquid completion portfolio.
Completion portfolio and liquidity needs
The hybrid approach addresses these issues. It is designed to focus on explicit factor exposure targets but be flexible so that it can capitalize on new investments that may not match precisely the factor targets.
The factor targets and resulting optimal asset allocation are the results of the analysis explained in subsequent sections. Implementing this allocation requires running two sub-portfolios.
One is the completion portfolio of public, listed assets. The other comprises the remaining, less liquid, private assets. When capital is called, the impact on the total real asset portfolio’s factor exposure is analyzed. Any variance from factor targets is then offset by adjustments to the completion portfolio.
The hybrid approach requires significant resource commitment on behalf of the investor and/or their investment managers to manage, monitor and adjust the portfolios over time. But the approach maintains the integrity of the strategic factor-based approach while allowing investors to take advantage of new deals and make tactical commitments when those opportunities arise.
Continue reading: Think real assets
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.