Advisers warming to real assets as stock market volatility picks up

The latest bout of stock market volatility is helping to make the case again for diversifying into assets that investors can actually touch and feel.

Physical real estate, real estate investment trusts and infrastructure master limited partnerships are the most common forms of the real assets that are hitting the radar screens of savvy financial advisers.

Much like the broader alternative investments universe, real asset investments are becoming an increasingly popular for reducing portfolio volatility.

As the data illustrate, most real asset investments are more about non-correlated exposure than white-hot performance.

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So far this year, real estate mutual funds tracked by Morningstar Inc. gained an average of nearly 10%, while the S&P 500 has been virtually flat.

Last year, when the S&P 500 gained 30%, the category gained 2.3%.

Morningstar doesn't have a specific category for master-limited partnership funds, but a screen of funds with MLP in the name found that the average return this year was 2.8%.

The MLP fund universe had an average gain of 24.4% last year.

“The main thing about real assets is you're getting the diversification of lower correlation to traditional assets, but you're also typically getting some inflation protection,” said James Cunnane, chief investment officer of the MLP & energy Infrastructure team at Advisory Research Investment Inc.

Even with inflation in the U.S. at barely discernable levels, the Fed's unwinding of quantitative easing and the looming threat of higher interest rates make the case for real assets an increasingly logical argument.

“The longer-term attraction of real assets is definitely the inflation sensitivity, because with higher inflation, you will be better off in real assets,” said Keith Black, managing director of curriculum and exams at the Chartered Alternative Investment Analyst Association.

“Another part of the attraction is that we're talking about real assets,” he added. “After the financial crisis, people realized that the stocks and bonds they owned were just paper assets.”

As a subcategory of alternative investments, real assets are sometimes overshadowed by the higher-profile hedge funds and private equity investments, but there are components of the financial advice community that are heavily committed to real asset exposure.

An as-yet released study by Cohen & Steers Inc. estimates that 90% of advisers are alre! ady using real assets for their client portfolios.

But despite the widespread use of real assets, advisers are only using real assets in 20% of their client base, according to the report, which was based on a survey of 660 financial advisers.

For those accounts containing real assets, the allocation is typically between 5% and 9%, illustrating a serious commitment to the asset class.

“It was a little surprising to us to find that among advisers using real assets, they are only using it in about one out of five of their client portfolios,” said Vince Childers, manager of the Cohen & Steers Real Asset Fund (RAPIX).

The research also found that only 40% of advisers are treating real assets as a core holding, with the majority using the asset class for tactical purposes.

Mr. Childers acknowledged his obvious bias when suggesting that investors should have between 10% and 20% allocated to real assets.

“We think people are under-allocated to real assets,” he said, citing an ability to hold value in an inflationary environment.

“But people need to understand that the portfolio diversification benefits go beyond inflationary scenarios,” he added. “In periods like we've seen recently, when stocks and bonds are not diversifying each other very well, that's the sweet spot for real assets.”

The broadest definition of real assets can include everything from direct ownership in real estate to fine art, but the Cohen & Steers study primarily focused on real estate, REITs, infrastructure MLPs and natural resource equities.

The survey found that more than 80% of respondents recognize direct real estate ownership as a real asset, but only about 30% are using direct real estate as a real asset investment.

REITs, which are used by 75% of the respondents, stood out as the most popular means of gaining real asset exposure. Interestingly, less than 35% of the respondents recognized REITs as a real asset.

Nearly 70% of respondents recognized prec! ious meta! ls as a real asset, but less than 40% say they are using precious metals as a real asset allocation.

Looking past what might appear to be some confusion or lack of communication surround real asset nomenclature, it is more important to focus on the growing appetite for the benefits that real assets can bring to a portfolio.

“People are worried about interest rates going up,” Jerry Swank, founder of Cushing Asset Management, said while discussing a new partnership to manage MLP and energy-related mutual funds with MainStay Investments.

“Don't underestimate this humongous energy renaissance going on in the U.S.,” he added. “We have a decade or more of growth in that area ahead of us.”

Just like there are multiple stripes of hedge funds and alternative strategy mutual funds, a real asset allocation should be built around diversification.

While an MLP fund allocation can hopefully catch the energy infrastructure renaissance, the REIT space is poised to benefit from increased demand for housing and office space.

“Right now we're seeing improving fundamentals in real estate, but they're still not building enough to make up for what hasn't been built over the past five years,” said Calvin Schnure, senior economist at the National Association of Real Estate Investment Trusts.

“Things that affect real estate are different than the things that affect stocks,” he added. “Improved job growth and consumer spending will benefit REITs because that translates almost one-for-one to an increased need for office space, because job growth means vacancy rates will fill faster.”