Real assets are tangible, physical assets such as real estates including commercial, residential and industrial properties, infrastructure such as transportation networks, utilities, power plants, bridges, farmland, and commodities. Hard commodities include natural resources and precious metals, such as oil, gold, silver, copper that can be mined or extracted and are driven by industrial demand. Soft commodities include agricultural products that can be grown or raised such as coffee, wheat, corn, grain, cattle, which can be affected by weather, season, and consumer demand.
Financial assets are intangible contracts including stocks and bonds. They can offer liquidity and efficient market access. For example, a stock represents a partial ownership of a company and a bond represents an issuer’s promise to repay the investor with interest. Financial assets usually entitle investors with cash flows such as dividends for stocks and interest payment for bonds.
Real assets can provide diversified sources of return with low correlation to the traditional asset classes such as bonds and stocks. Real assets can be effective inflation hedges as their values adjust with rising price levels. During inflationary period, fixed-rate financial assets often lose their purchasing power, so higher allocation to real assets will be essential for long-term portfolio returns. However, real assets are usually less liquid and more complex to invest.
Many real assets are scare with limited supply and high demand. The demand for these assets often pushes the prices higher. Real assets such as real estates generate income (rent) that can adjust upward with inflation, and the property value can also increase with inflation. While costs also rise, ability to raise rents keep the real return intact. Commodities and natural resources also tend to increase in price during inflationary period. Infrastructure assets including utilities, toll roads and pipelines often have their pricing tied to inflation or they have a cost pass-through system.
Allocating 10-15% to real assets in your portfolio can reduce overall volatility as these assets appreciate during inflationary period while stocks and bonds are both vulnerable when the inflation rises. As investors’ focus pivots towards securing income growth, real estate can be a good investment option that can generate income streams that can outperform inflation, which can be a primary driver of investment strategy.