Over the last few years we’ve seen the emergence of a new kind of asset class, called 'real assets'. In the olden days these would tend to be called alternatives and included stuff such as property and real estate investment trusts (Reits).
The number of ‘alternative’ themes has expanded over time and now we’ve got a cornucopia of different niches, all boasting a common set of characteristics. The key idea is that everything, from asset-backed lending to infrastructure and property funds, contains real asset backing. This usually means some form of property or equipment backing which can be resold in distress, though infrastructure projects by contrast boast an explicit government guarantee of payments.
These real assets produce cashflows which help power stable (we hope) dividend cheques, and also give investors the hope that the income yield will increase alongside inflation. Volatility has, mostly, been below that of mainstream equities but more than what we’d expect for bonds. All of which points to these real assets being in effect a kind of hybrid asset class, part fixed income (stable income), part equities (share prices can increase markedly).
But there is another important shared characteristic: the underlying investments, be they buildings, private finance initiative contracts or asset-backed lending, all boast relatively low levels of liquidity. In other words, they are much more illiquid than either large-cap equities or, for that matter, equally liquid, large-cap corporate bonds.
This relative illiquidity can be a real turn-off in a savage downturn. In the global financial crisis of 2008 and 2009, many Reits derated dramatically as investors rushed to the door. So, although volatility over the long term should be less than for equities that doesn’t always apply when investors want and need immediate liquidity, especially in a massive sell-off.
Overall, though, I think these real assets are increasingly not that alternative and deserve a place in most investors’ portfolios, especially those with a more defensive, income bias. Ideally, they could sit alongside mainstream equity holdings and bond funds.
How to pick the right assets?
But there’s a catch. How to pick the right underlying investments? Precisely because the spectrum of real assets is so huge, stock selection is a real challenge. I haven’t even included really alternative stuff such as music royalties, buying ships or even lending to drugs companies using their royalties.
By their nature, these less-than-liquid assets require sector expertise and a good head for digging into the finances of a business, beyond the profit and loss account. A working knowledge about how debt can be subordinated in mezzanine structures is probably also useful, alongside a passing knowledge of regulatory affairs, especially as they apply to how governments want to involve private capital in public projects.
My guess is that for most private investors this knowledge is probably somewhat lacking and I’d even suggest that most financial advisers and wealth managers might struggle. My take is that a fund-of-fund structure makes a great deal of sense in this space, despite my reservations about layering fees upon fees. Having an active fund manager pick your underlying assets and then identifying the best funds which specialise in the likes of loans, properties or infrastructure contracts is probably worth approaching 1% a year in fees.
The good news is that over the last few years we’ve seen a growing number of real asset funds emerge. In the traditional funds classification universe they tend to sit uncomfortably in the specialist assets universe but I think their appeal is fairly widescale. They tend to pay out a decent, inflation-backed, regular income, with most at around 4% a year. They also tend to invest in a tightly-held portfolio of underlying funds, and occasional direct shares in, say, utility companies, usually amounting to between 20 and 40 holdings.
In terms of performance the sector is still fairly young, so I can’t make any sweeping generalisations about recent returns but a few do hint at the hard numbers. Architas, for instance, has boasted its own Diversified Real Assets fund since 2014 although this fund (the biggest by far in this small but growing segment) is slightly more ‘conventional’ in that it also boasts a heavy weighting to underlying bond funds. In 2018 this fund lost 2.9%, in 2017 it gained 2.1% and in 2016 it rose 8.1%.
Waverton has also been running segregated client accounts with an explicit real asset backing which resulted in them launching its own Real Assets dedicated fund. Internal data from Waverton suggests that annualised returns have been running at an average of around 6%, with the last five years producing a 30% gain. Volatility has also been markedly lower, at around 6% to 7%.
Classic investment for the mainstream
So, in sum, a classic hybrid, middle-of-the-road, defensive investment return for the mainstream: lower volatility, decent income, and steady middle single digit positive returns on average. Whether this is true in the future is anyone’s guess but I think you’d agree that this isn’t really that ‘alternative’ anymore – it should be a fairly popular investment strategy for most mainstream investments.
In the box below I’ve listed what I think are the most interesting real asset funds out there and they vary enormously in size, with the well-established Architas fund towering in assets over newbie diminutive fund VT Reyker Real Assets, which has only been going since November 2018. The latter fund has the highest ongoing charges figure at 1.5% whereas the Sanlam fund is the cheapest in my small peer group. Overall I’d factor in about 1% per annum in costs with the underlying funds also levying their own fees.
In most cases property funds, mostly Reits, tend to account for around 25% to 35% of the portfolio with infrastructure funds probably the next popular at between 15% and 25%. You’ll also see lending funds, usually asset backed, coming in at between 15% and 30%. This lending activity help boost the yield and should be less volatile during most of the cycle but its not unreasonable to expect losses during a future downturn as defaults shoot up.
|Architas Diversified Real Assets||1.14%||Property 28%, bond funds 28%||n/a||£240m||3.32%|
|Waverton Real Assets Fund||1.06%||Property 26%, specialist lending 18%, infrastructure 15%, asset finance 13%, commodity related 9%||38||£45m||Projected 3.8%|
|Sanlam Real Assets||0.97%||Infrastructure 28%, property 27%, renewable energy 27%||26||£93m||4.30%|
|VT Reyker Real Assets||1.50%||Property 39%, infrastructure 19%, energy assets 12%, asset-backed income 8%||21||£3.80m||Target 4% plus|
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