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Building the ideal real assets portfolio

by Steve Bergsman

The term “real assets” is the mundane name for a bucket of more exciting alternative investments that includes real estate, infrastructure, commodities, timberland, metals and mining, and farmland. The mix differs among the varied managers of real asset portfolios, but the objective is usually the same: a mix of yield plays that also provide diversification and hedge against inflation.

Different investment managers use different groupings to form portfolios, so total returns can vary substantially.

For example, Vince Childers, a senior vice president and real assets portfolio manager at New York City–based Cohen & Steers, basically builds a real asset portfolio using REITs, commodities, infrastructure and natural resource equities, the latter being a grouping of agribusiness, energy, and metals and mining. Brent Burnett, a senior consultant at Real Asset Portfolio Management in Portland, Ore., says his company’s portfolios invest in the subsets of real estate, energy, timber, minerals and mining, infrastructure, and agriculture.

The trick for investment managers is weighing one subset of investments against another because they all move differently depending on global economic factors.

Hands down, 2014’s best performing real asset subset to date has been public infrastructure securities; the segment was up 19.4 percent at the end of August as measured by the Dow Jones Brookfield Global Infrastructure Composite Index. Infrastructure, often considered to be about toll roads and airports, actually has a big energy component, particularly oil and gas storage and transportation companies and master limited partnerships. Infrastructure securities have returned on average 20 percent a year for the past five years, says Burnett, but if you just look at the energy subsector of the index, that alone has risen 24 percent as of end of August.

“The entire infrastructure space over the last several years has really evolved,” Childers observes. “A lot of people have gotten interested because of the pipeline story, the North American energy renaissance story, but that’s only a piece of the broader global infrastructure universe.”

Unless there are macro-shocks in the global economy, the consensus is infrastructure will continue to perform well through the end of the year.

Right behind infrastructure has been real estate, but how one benchmarks the sector makes a difference. If one is dealing solely in real estate investment trusts, the FTSE NAREIT U.S. Real Estate Index year-to-date has been up more than 15 percent. However, some portfolio managers benchmark to the FTSE EPRA/NAREIT Global Real Estate Index, which has been up about 10 percent year-to-date.

Burnett says many of his clients include publicly traded securities in their equity portfolios but that his firm primarily focuses on private investment in real estate. He benchmarks those investments to the NCREIF Property Index, which was up 5.7 percent through June 30. “Compared to the REIT index, the private market has lagged this year, but that’s not unusual as REITs tend to have more equity market correlation and run up and run down faster,” Burnett says.

Energy and metals and mining have been middling to sad performers in 2014, depending on the different benchmarks. Childers reports global energy was up 9 percent and metal and mining 5.7 percent through August.

Although private energy investments are especially difficult to benchmark, energy commodity prices have been fairly strong in the first half of the year. The average natural gas spot price was up 14 percent over second quarter 2013, while West Texas Intermediate ended the second quarter up 8 percent.

Metals and mining have struggled over the past several years, but appears to be showing some improvement. For commodities, Burnett benchmarks to the Dow Jones Commodities Index, down –1.3 percent year-to-date. “It’s been a tough year for commodities and short-term is difficult to forecast,” Burnett says. “However, long-term fundamentals for commodities look good, and we expect to see improvement over the rest of the year.”

The real surprises this year have been the relatively weak performances of timberland and agriculture. Since its inception in 1986, the average return on the NCREIF Timberland Index has been 12.5 percent. This year the return has been 2.7 percent through June. “Asian economies softened in the first quarter, and a lot of the Northwest timber goes to China and other Asian countries. Also, U.S. housing starts continue to be well below peak levels,” Burnett explains.

He expects second half 2014 to be better.

As to agriculture, which has been the best performing asset class on a total return basis going back 15 years, the NCREIF Farmland Index was up 4 percent through June. Investors should not expect much change for the remainder of the year.

So what is the short-term view of real assets in general? Here is a tip from a tout: “A lot of what we have seen post-crisis was an extended recovery process, where more income-oriented assets like REITs and infrastructure have outperformed, while commodity complex assets brought up the rear,” Childers notes. “As the cycle matures, there will be a transition to the commodity complex. Based on valuation, we have started to make allocations more toward ‘natural resource equities.’”

Steve Bergsman is a freelance writer based in Mesa, Ariz.

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