Real world assets

What Are Real World Assets?

Real world assets refer to tangible, physical assets that derive their value from their intrinsic worth and utility, rather than from a contractual claim or a legal document. As a key component of investment management within the broader category of asset classes, real world assets offer investors a distinct avenue for portfolio diversification. Unlike financial assets such as stocks or bonds, which represent claims on underlying entities or income streams, real world assets include categories like real estate, infrastructure, and commodities. These assets are often sought after for their potential to act as an inflation hedge and for their typically low correlation with traditional financial markets.

History and Origin

The concept of investing in real world assets dates back to the earliest forms of property ownership and agricultural practices, where land itself was a primary source of wealth and value. Humans have cultivated land and built structures for millennia, long before the advent of modern financial markets. Villages, roads, and bridges began to take on value, establishing the fundamental principles of real estate and infrastructure²⁰.

While investment in physical assets has always existed, their formal recognition as a distinct asset class within modern investment portfolios began to gain prominence in the mid-20th century. A significant milestone in making real world assets more accessible to a broader range of investors was the introduction of the first publicly traded Real Estate Investment Trust (REIT) in 1965. This development allowed investors to gain exposure to income-generating real estate without direct property ownership. The subsequent adoption of modern portfolio theory by institutional investors in the latter half of the 20th century further cemented the role of real estate and other real world assets in diversified portfolios¹⁹. Over time, other structures, such as Master Limited Partnerships (MLPs) for energy and infrastructure assets, also emerged, expanding the avenues for public investment in these tangible holdings.

Key Takeaways

• Real world assets are tangible, physical holdings like real estate, infrastructure, and commodities, valued for their inherent worth and utility.
• They often serve as an effective inflation hedge due to their direct link to physical goods and services.
• Real world assets can provide significant portfolio diversification benefits due to their low correlation with traditional stocks and bonds.
• Investment in these assets can offer stable income streams, particularly from properties and infrastructure projects with long-term leases or contracts.
• Their illiquidity, while a potential drawback, can also command a "liquidity premium," offering higher potential returns for investors willing to lock up capital for longer periods¹⁸.

Interpreting Real World Assets

Interpreting real world assets involves understanding their fundamental drivers, which often differ from those affecting traditional financial securities. Unlike stocks whose value might be heavily influenced by corporate earnings guidance or market sentiment, the value of real world assets is often tied to macroeconomic factors such as population growth, urbanization, technological advancements, and the availability of natural resources¹⁷. For instance, the value of a piece of real estate is directly linked to factors like location, rental income, and local supply and demand dynamics. Similarly, the value of infrastructure assets like toll roads or utility networks depends on user volume, regulatory frameworks, and essential societal needs. Investors assess these assets based on tangible metrics like cash flow, occupancy rates, and commodity prices, which often provide more predictable and durable income streams compared to the more volatile nature of some financial market returns¹⁶.

Hypothetical Example

Consider an individual investor, Sarah, who has a traditional portfolio heavily weighted in stocks and bonds. Concerned about rising inflation, Sarah decides to diversify her holdings by adding real world assets. She allocates a portion of her portfolio to a Real Estate Investment Trust (REIT) that owns a portfolio of industrial warehouses and also invests in an exchange-traded fund (ETF) focused on global infrastructure projects.

In a scenario where equity markets experience a downturn and inflation unexpectedly rises, the rental income generated by the warehouses in her REIT portfolio might continue to provide stable cash flow, potentially adjusting upwards with inflation clauses in leases. Similarly, the infrastructure ETF, holding stakes in essential utilities and transportation networks, could offer steady yield and exhibit less volatility than her stock holdings, helping to cushion the overall impact on her portfolio. This strategic asset allocation to real world assets aims to improve her portfolio's resilience against market fluctuations and inflationary pressures.

Practical Applications

Real world assets appear across various sectors of the economy and investment landscape. They are a significant focus for institutional investors such as pension funds, endowments, and sovereign wealth funds, which often allocate a notable portion of their portfolios to real estate and infrastructure due to their potential for stable returns and diversification¹⁴, ¹⁵. These large investors may engage in direct property investments, invest in private equity real estate funds, or utilize publicly traded vehicles like REITs and MLPs¹³.

Beyond large-scale institutional investment, real world assets are pivotal in global commerce and everyday life. For instance, the global demand for data infrastructure and energy, driven by digitalization and artificial intelligence, is creating new opportunities for investment in real assets like data centers and renewable energy projects¹². Governments also invest heavily in infrastructure to support economic growth and public services, creating a robust framework for private investment in these areas¹¹. Real assets, by their nature, provide the essential framework and resources for the functioning of the world economy¹⁰. A comprehensive overview of current trends and opportunities in the real assets market is often provided by market research firms, detailing the evolving landscape for these investments.⁹

Limitations and Criticisms

Despite their benefits, real world assets come with certain limitations and criticisms. One of the primary drawbacks is their inherent illiquidity. Unlike publicly traded stocks or bonds that can be bought and sold quickly on exchanges, real world assets often involve substantial transaction costs, lengthy due diligence, and a lack of readily available buyers or sellers at desired prices⁷, ⁸. This can make it challenging for investors to exit positions quickly, especially in distressed markets. The ease of trading publicly available assets can tempt investors to make impulsive, suboptimal choices, whereas the illiquidity of real assets may force a more disciplined, long-term approach⁶.

Another criticism revolves around valuation. Due to their unique characteristics and the absence of a continuously traded public market for many individual assets, valuing real world assets can be complex and less transparent compared to financial assets⁵. Appraisals are often used, which can be subjective and may lag behind actual market movements³, ⁴. While real assets are generally considered to offer strong long-term returns and stability, their performance can still be influenced by market cycles, economic downturns, and geopolitical events, as demonstrated by the challenges faced by the real estate sector in recent years¹, ².

Real World Assets vs. Financial Assets

The distinction between real world assets and financial assets lies primarily in their form and source of value.

While financial assets represent ownership claims or promises of payment, real world assets possess inherent physical worth. This fundamental difference means they often behave differently within a portfolio, leading many investors to combine both types to achieve broader portfolio diversification and manage different types of risks. The ease of liquidity for financial assets allows for frequent trading, while the less liquid nature of real world assets typically necessitates a longer-term investment horizon.

FAQs

Q1: Why are real world assets considered an inflation hedge?

A1: Real world assets, such as real estate and commodities, are often considered an inflation hedge because their values and the income they generate (like rents or commodity prices) tend to increase with general price levels. As the cost of goods and services rises due to inflation, the value of physical assets often follows suit, helping to preserve purchasing power.

Q2: What are the main types of real world assets?

A2: The main categories of real world assets include real estate (commercial, residential, industrial), infrastructure (roads, bridges, utilities, communication networks), and commodities (raw materials like oil, gold, agricultural products). Other forms may include timberland and farmland.

Q3: How do investors typically gain exposure to real world assets?

A3: Investors can gain exposure to real world assets through various means. This can involve direct ownership of properties, investing in Real Estate Investment Trusts (REITs) or Master Limited Partnerships (MLPs) for public market exposure, or participating in private equity funds that specialize in real estate, infrastructure, or natural resources. These varied approaches allow for different levels of capital commitment and liquidity.