The battle with Inflation – a case for real assets

We are experiencing our highest inflation levels in over 40 years and despite drastic measures globally, inflation is expected to remain elevated for some time.

Many client portfolios are allocated for an environment where inflation was non-existent and accommodative policies helped foster robust economic growth and a strong equity market. But as conditions change to slow growth along with higher inflation, there is a growing concern, and families want to protect their investment portfolios. Financial advisors everywhere are searching for strategies that adapt to current market dynamics. 

First, we need to understand what real assets are: 

Real assets include real estate, infrastructure, commodities, and resource equities—These may offer an effective solution amid inflation risks. 

Background 

Inflation has surged to near 40-year highs, and evidence is mounting that the spike in prices is more than temporary. 

A major shift in the drivers of this business cycle points to enduring inflation and a prolonged environment favorable for real assets. 

The global economy’s rapid recovery from the Covid pandemic has been characterized by inflationary forces (wage/price pressures) and insufficient aggregate supply to keep up with an over-stimulated private sector. This convergence of supply and demand pressures is jointly driving inflation higher. Add to this equation the Russia–Ukraine war continues and creates the likelihood that supply disruptions will endure. 

Inflation, therefore, it seems, is likely to stay well above the previous cycle average. As today’s strong demand and impaired supply point to persistent inflation forces, investors may want to consider real assets, which often have built-in inflation escalators or may benefit directly from rising commodity prices. 

Positioning Portfolios for Long-Term Inflation Risk 

Real assets can help defend against inflation. The definition of real assets is real estate, infrastructure, and commodities. What unifies real assets more than any other attribute is that their returns have historically benefited from inflation surprises. In other words, this means real assets have tended to outperform during periods of rising and unexpected inflation, contrasting with the modest or negative inflation sensitivity of stocks and bonds.

The economic drivers of real assets are often directly or indirectly tied to inflationary trends; this linkage historically has resulted in outsized returns when inflation exceeds expectations. An allocation to real assets may therefore help to preserve future purchasing power, potentially offsetting the vulnerability to unexpected inflation that is historically common to traditional portfolios of stocks and bonds.

Why Real Assets?  

Real assets are the structures and raw materials that economies rely on to function and be productive. That includes the properties where we live, work, and shop; the infrastructure that provides power and water and enables transportation and communications; and the basic natural resources, such as food and energy, that sustain societies. 

A diversified blend of real assets—including real estate, infrastructure, commodities, and natural resources should help enhance a portfolio in three key ways:

• Positive inflation sensitivity to help mitigate the potentially damaging effects of accelerating inflation. 
• Diversification potential from distinct performance drivers typically results in low correlations, both among real assets categories and vs. stocks and bonds. 
• Attractive return potential over full market cycles, with a history of attractive risk-adjusted performance.

Diversification 

Every Investment professional is aware of the importance of diversification in every asset allocation.

The goal of diversification an investing in assets that have negative correlations in different economic and market environments, so when one asset zigs, the expectation is that another will zag. Real assets’ distinct economic sensitivities tend to differentiate them from traditional risk assets such as stocks and bonds and should not be correlated at all to markets. 

Why Now? 

Priced attractively and with resilience in the face of inflation, portfolio diversification, and historically attractive returns through an economic cycle are three reasons an allocation to real assets in a diversified portfolio makes sense in most economic regimes. Potentially adding to the asset class appeal are attractive relative valuations. 

Our lives today are characterized by repeated and unprecedented surprises, this could impact our families’ destinies so now is the time to align our investment strategy with our life goals and introduce asset classes that will help us on our journey.