Research, published by Deutsche Asset & Wealth Management’s institute, shows illiquid assets such as timberland, farmland, property and infrastructure offer significant diversification benefits, exceeding that of a traditional portfolio consisting of public equities and government bonds. However, most do not provide a hedge against inflation.
Quarterly returns of all real asset classes have low correlations with equities and long-maturity bonds as well, the paper’s author K.J. Martijn Cremers, said. Correlations across real asset classes are also limited.
In establishing the diversification benefits the researchers used a portfolio consisting of equity and bonds (e.g. 60% in the S&P 500, 30% in 20-year bonds, and 10% in one-year bonds) with an equally weighted real asset portfolio across the four main areas of timberland, farmland, infrastructure and property.
The paper reads: “Based on the longest time period considered of 1978-2012, adding real assets to the equity/bond portfolios would have resulted in significantly lower volatility but would have left the average returns largely identical. The diversification benefits seem most pronounced for direct investments in farmland and infrastructure.”
In comparing the risk-return trade-off, energy infrastructure investments significantly outperformed all other real asset classes with an annual Sharpe ratio of 0.70, according to the paper. Farmland and property both have a Sharpe ratio of close to one.
In addition to highlighting the benefits of using real assets, the paper also touched on their growing use by institutional investors, particularly over the past 10 years. Of the four main real asset areas, European investors have a bias towards natural resources, although infrastructure appears to be catching up fast with 39% of institutional funds likely to hold this asset.
