As virtual board meetings have led to real investment decisions in recent weeks, the hunger for an unusual set of diverse investments is on the rise, according to Harsh Parikh, principal at PGIM Institutional Advisory & Solutions Real Assets Research Program.
At the $1.3 trillion firm, they have tracked institutional investors increasing their allocations to real assets, over and above their allocations to real estate. In fact, in some instances real estate becomes one of many sub-slices of the real assets portfolio.
There seems to be general misconception about real assets in that it involves investing in physical commodities like oil, which returned -56.5% in March as Saudi Arabia and Russia disagreed on a production cut, according to PGIM. But the firm says, that in today’s economy, data are more real than oil.
“Recently, some examples of real assets investing include investing in railcar-leasing or purchasing a share in free cash flow from a gold mine,” said Parikh. “Because of the wide variety of investing options in real assets, investors will likely need to tailor their allocations in their real asset strategy portfolios to meet specific investment objectives.”
PGIM is surveying the real asset allocations of 15 large U.S. public pension plans. They have found that investors allocate to a wider variety of real assets such as real estate, REITs, infrastructure, natural resources, farmland, timberland and commodities.
“Overall, we find that allocations to real assets are increasing,” he said. “It is not only increasing in real estate but also in other real asset categories as well. The largest allocations are to real estate, infrastructure and natural resources.”
Last year PGIM published “The Diversity of Real Assets”, looking at how the macroeconomic and market sensitivities of real assets differ, not only at the asset class level but also at the sector level. Accounting for these differences, the team outlined how aligning the choice of real assets and sectors with an investor’s investment objective is necessary.
The asset breakdown includes: farmland, timberland, real estate, infrastructure, gold. And then at the asset class level, Parikh added that investors have even more choices.
For example, investors may choose to manage a farm, lease the farmland to a farmer, or repurpose the land. Then in an area such as gold, the institutional investor can invest in gold bullion, ETFs, futures, gold miner equities or royalty agreements.
During this time of pandemic, many of the goods and services that have been in high demand — yes, even toilet paper for sanitation — have a common theme that can be expressed in real assets, according to PGIM.
PGIM recently outlined its current assessment of each sub-asset class. Some of the bright spots including farmland where orange juice returned 25.3% and wheat that was up 8.4% in March. Also a farmland REIT was up 3.6%.
In timberland, exposure to timberland REITs returned on average -14%. But high demand for toilet paper and packaging will translate into a greater demand for pulpwood timber, providing price support in the first quarter at least.
Real estate shows an increased demand for data centers as people work/study from home. And with increased internet traffic, PGIM also tracked increased capital expenditure from telecommunication companies.
Lastly, gold has a role to play in both stagflation and stagnation environments, they said. In March, gold’s daily correlation to equity returns may have been positive, but overall during the month the asset returned 1.6%.
“Institutional investors have a wide variety of options to invest in real assets,” Parikh said. “This includes investing in open-end funds, closed-end funds, co-investing along with a GP or investing directly.
PGIM’s research shows that the options and allocations should be customized based on an institutional investor’s investment objective and investment horizon. In the instance of gold investing, allocations to gold bullion vs. gold miner equities would depend on whether the investment horizon is six months versus five years.
The allocations would also depend on the chief investment officer’s investment objective is inflation protection or stagnation protection. In a stagnation protection portfolio, for instance, would combine some defensive assets and sectors with the expectation of performance in low growth and low inflation economic environments.
Benchmarking is evolving too, as some allocators use an absolute return target like CPI + 5% for real assets. While over the long term there may be credence in comparing asset class performance to such a target, in reality asset class performance is a lot more volatile and requires a better benchmark, according to Parikh, who added that the benchmark technology is also evolving.
However, investors like DC plan sponsors would mainly hold liquid public real assets. More recently, for retail investors, there have been innovations in vehicle offerings to include private real assets like real estate using closed end funds such as interval funds which are registered under the Investment Company Act of 1940.
Parikh is working on a forthcoming paper, “What’s in Your Real Asset Portfolio?” The team evaluated over 20 liquid real asset funds and so far he has found that the investment objectives and benchmarks are very different.
“For example, in commodities, an energy-centric commodity portfolio may select a benchmark that has larger energy and crude oil weights, but a more diversified commodity portfolio may appropriately select a diversified commodities benchmark,” he said.