What Are Real Assets? Understanding Tangible Investments
Real assets are tangible, physical assets that can be exchanged for cash, owing to their use in manufacturing and consumer goods, and other purposes. Real assets, as a category, may include precious metals, commodities, real estate, infrastructure, and more.
Typically, real assets are considered a type of alternative investment, owing to their low correlation with traditional asset classes such as stocks and bonds. As such, real assets may provide some portfolio diversification. But real assets are also susceptible to specific risks pertaining to each sector.
Key Points
• Real assets take their name from the fact that they are tangible, physical assets, as opposed to financial assets (like stocks and bonds) or intangible assets (like a brand).
• Real assets have a cash value, and can generally be traded for cash. They typically include real estate, land, commodities, infrastructure, precious metals, and more.
• It’s possible to invest in real assets directly (by owning the physical goods, resources, or structures) or indirectly (via mutual or exchange-traded funds).
• They are considered a type of alternative asset, because most real assets are not correlated with conventional asset classes, and thus may provide some portfolio diversification, and potential returns.
• Real assets come with specific risk factors that pertain to each type of tangible asset, in addition to the risks that come with most alts: e.g., illiquidity, lack of transparency, less regulation.
Defining Real Assets
What is an asset? On the whole, assets can be considered tangible (e.g., land), intangible (e.g. a brand or trademark), or financial (e.g. shares of stock). While real assets have a cash value and can be exchanged for cash, they are not considered a type of financial asset because they are not securities.
Also, real assets are considered a type of alternative investment. Alts tend not to move in sync with, i.e., they’re not typically correlated with conventional assets like stocks and bonds. But like all types of alternative investments, real assets come with specific risks, including lack of liquidity, transparency, and less regulation in some cases.
Characteristics of Real Assets
The primary characteristic of real assets is that they are physical. They can be objects, goods, resources, or structures that have a specific cash value and can be traded for cash in certain markets.
However, real assets are considered non-securities, because they do not derive their value from a contractual ownership arrangement like stocks, bonds, exchange-traded funds (ETFs), options, and more.
Real Assets vs. Financial Assets
Financial assets fall into the category of securities; generally speaking there are debt securities (like bonds) and equity securities (stocks), as well as derivatives (options and futures). Real assets are non-securities.
• Securities are financial instruments that can be traded on an exchange, with an expectation of making a profit. More important, securities are fungible, meaning the value of one unit is interchangeable with another of the same type of unit: e.g., a share of stock in Company A is the same as another share of that stock.
• Real assets are physical goods, and in many cases they are not fungible: one type of property or infrastructure is not interchangeable with another. That said, commodities are a type of real asset, and are generally fungible: one barrel of crude oil is the same as the next.
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Types of Real Assets
As noted, real assets consist of physical, tangible goods and resources. But while one stock generally behaves the same as another stock, each type of real asset has to be considered individually to understand its benefits and risks.
Real Estate
Real estate includes a wide range of property types and investment choices: e.g., commercial real estate, industrial real estate, healthcare facilities, rental properties, and more. While it’s possible to invest directly in real estate, it’s also possible to buy into a type of pooled investment like real estate investment trusts, or REITs.
Real estate may offer passive income (i.e., from rent), or gains from the sale of properties, but real estate investments come with potential risks: local laws and regulations can change; property can be damaged by extreme weather; interest rate risk can impact property values.
Commodities
Commodities include numerous raw materials, including agricultural products like corn and coffee; precious metals such as copper or nickel; energy sources (including renewables), and more. Commodity trading typically involves futures contracts, but it’s possible to invest in commodities via index funds and mutual funds, or ETFs.
These assets, owing to steady demand, may offer the potential for profits. They may help hedge against inflation. That said, the value of commodities can be impacted by weather, supply chain breakdowns, market fluctuations, and other factors, which makes them risky. Commodities can lose value for a number of reasons, and direct investments in commodities lack certain investor protections offered to other securities.
Infrastructure
Infrastructure assets are durable structures that provide public services, utilities, and the like to enable the smooth functioning of society. Infrastructure includes durable structures like bridges, roads, tunnels, and schools, as well as energy infrastructure like power plants. Infrastructure is typically stationary, has a long period of use, and generates predictable cash flow (via utility payments, tolls, and so on).
While it can be difficult for individual investors to invest directly in infrastructure, it’s possible to invest in municipal bonds, or funds that offer exposure to companies involved in infrastructure.
Investing in infrastructure comes with specific risks investors should consider, including interest-rate risk (which can affect access to loans, and interest on bonds), regulatory issues, climate and weather challenges, and more.
Precious Metals
Generally speaking, precious metals consist of a group of natural assets, including gold, silver, platinum, iridium, and others. Investing in precious metals may be appealing as many metals tend to retain value owing to their scarcity, their critical role in manufacturing and technology, and because some (like gold and silver) are themselves used as a store of value.
For many individual investors, it may not be obvious how to invest in gold, silver, or other metals. Though it’s possible to buy bullion or bars directly, it’s also possible to invest in ETFs that are invested in gold or precious metals, or in stocks of mining companies, and the like.
The risks of investing in precious metals include potential changes in demand, technological innovations that may require more or less of a given metal, supply chain issues, worker safety, and more.
Recommended: Why Invest in Alternative Investments?
Benefits and Risks of Investing in Real Assets
In addition to the advantages and disadvantages of different types of real assets noted above, there are a few other factors investors should consider.
Inflation Hedge
Inflation essentially decreases a dollar’s purchasing power, and a hedge against inflation can offer a potential upside.
In some cases real assets can provide a hedge against inflation. For example, assets that benefit from steady demand, like commodities, may help offset inflation’s bite. Also, land or real estate may rise in value even when the purchasing power of the dollar is declining, which may offer a potential inflation hedge.
That said, it’s impossible to predict for certain which asset classes will help to mitigate inflation, and there are no guarantees.
Portfolio Diversification
Another factor investors should consider is the potential benefit from diversification, which is the practice of investing in different asset classes to help mitigate risk. Diversifying your assets may help offset some investment risk.
Diversification is complex, however, and involves more than just including alternative investments along with equities and fixed income. Investors need to consider how certain investments, like tangible assets, might provide some sense of equilibrium in their portfolio if conventional strategies are down.
Potential for Steady Income
As discussed, some types of real assets, like infrastructure investments, can become a source of steady income. For example, roads and bridges and public transportation require a high initial investment, but then they may provide a predictable revenue stream from tolls and fares and so forth.
The same is true for some types of municipal power plants and other energy sources that supply utilities, and derive steady payments over time.
Liquidity Concerns
Taken as a whole, however, real assets are quite similar to other types of alternative investments in that they lack the liquidity and easy access to cash that most conventional investments provide.
Liquidity risk is something all investors must take into account when choosing investments, as the inability to enter and exit positions with ease, and as needed, can impact one’s goals.
Market Volatility
All markets fluctuate to some degree, but some markets are more volatile than others. When it comes to deciding whether to invest in real assets, investors must do their due diligence because the market for each type of tangible asset is vastly different from another.
Just as understanding volatility in the stock market is key to making smart choices about equities, it’s essential for investors to consider the real estate market for a property they might invest in, or the futures market for investing in commodities, and so forth.
Incorporating Real Assets into Your Investment Strategy
Would investing in real assets make sense in your portfolio? There are a few factors to consider.
Asset Allocation
Asset allocation is basically the mix of stocks, bonds, and other investments in your portfolio. While a standard allocation usually includes these conventional asset classes, some investors also include other choices such as commodities, real estate, private equity, and more.
Deciding on the right allocation for your portfolio means thinking about your goals, time horizon, and how much risk you’re willing to take on. Given that real assets are often higher-risk investments, but aren’t correlated with traditional assets, investors may want to consider the advantages and disadvantages before deciding on an asset allocation that makes sense.
Direct vs. Indirect Investment Methods
Owing to the physical nature of real assets, it’s possible to invest in many real assets directly (e.g., owning rental property or gold bullion) as well as investing indirectly in real assets.
For example, commodities are typically traded via futures contracts. A commodity futures contract is an agreement to either buy or sell a specified quantity of that commodity for a specific price at some point in the future. While it’s possible to end up with actual physical commodities this way (e.g., bushels of corn or barrels of oil), for the most part futures are an indirect way to gain access to the commodities markets.
REITs and ETFs
Real estate investment trusts (REITs) and ETFs are two other common instruments for investing indirectly in real assets.
• A REIT is a trust that owns income-generating properties, so that investors are spared the hassle of direct ownership. A REIT may own warehouses, retail stores, storage units, hotels, and more. REITs can focus on a geographic area or specific market (like healthcare). A REIT is required to distribute 90% of its income to shareholders, so owning shares of a REIT may provide passive income, as well.
• ETFs are another way to invest indirectly in certain types of real assets, because these funds invest in companies that either produce, process, or in some way support a given type of real assets.
For example, there are ETFs that invest in mining, equipment, or technology companies in the precious metals and commodities sectors. Likewise, there are ETFs that invest in companies that support infrastructure projects.
Investors who are interested in exploring real assets are not limited to direct investment strategies; there are other options to consider.
The Takeaway
Real assets are tangible assets like real estate, infrastructure, or commodities, and are considered a type of alternative investment. Alts are not typically correlated with traditional assets like stocks and bonds, and thus may provide portfolio diversification that can help mitigate some risk factors. But like all types of alts, real assets come with specific risks, including lack of liquidity and lack of transparency.
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FAQ
How do real assets perform during economic downturns?
Although some alternative investments may not be affected by a downturn, the markets for specific assets can react differently, depending on the economic conditions. For example, if stocks are down, real estate may not be impacted at all. When interest rates fluctuate, the cost of loans can impact real estate values and infrastructure projects, but not necessarily commodities. It’s incumbent on each investor to consider the pros and cons of any investment before putting money into it.
What percentage of a portfolio should be in real assets?
Deciding on the percentage any asset class should have in your portfolio is a personal calculation, taking into account your goals, time horizon, and stomach for risk. It’s especially important to consider that real assets are illiquid, a risk consideration that can impact whether you want to invest in real assets at all.
Are real assets suitable for all types of investors?
No. Real assets are better suited to experienced investors, who may have the skills to navigate the complexities of real asset markets, pricing, risks, and so forth.
Photo credit: iStock/Edwin Tan
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