25th March 2022
What are Real Assets? Type that into google, and you will learn that they are physical assets with some sort of intrinsic worth – distinct from financial assets, whose value is derived from contractual obligations. Real Assets thus include property, commodities, precious metals, land and infrastructure (to name a few).
The confusing bit is the word “real”. In economic terms, “real” means after the impact of inflation. I.e. a real return is a nominal return adjusted for inflation. And hopefully our readers will know that this is the only return Hawksmoor Fund Managers care about (in fact it’s real returns after taxes and charges too – because that’s what the underling clients get). I have no idea why the word “real” became used in this context, but it has appeal. Investing is about maintaining your purchasing power through time (as a minimum objective) – so investment returns that mean anything have to be adjusted for inflation, which erodes purchasing power. A return that is “real” is one that actually translates into a measure of success. A positive nominal return isn’t “real” if it can’t keep pace with inflation and is thus of little use to the client.
But “real” doesn’t necessarily mean these assets should be expected to keep pace with inflation. And this is a crucial distinction and one that could be solved by using a different word – “physical” perhaps. So, what’s the point of the distinction? Why label these assets as “real” at all?
I think that’s THE question, and the best answer is one that enables us to distinguish between the fact that an equity or a bond is a contractual obligation to receive a stream of cash flows and is not “physical”. An equity is a share in a company, which might own assets, but a company itself is a collection of contractual relationships (anyone who did economics at university might remember “the Theory of the Firm”). The interesting thing about “real assets” is that you own a physical thing. That thing might give you the ability to earn cash flows by renting it out (like a building) or chartering it out (like a ship) or selling capacity (like a battery). Or it might not – you can’t rent commodities out – you (usually) consume them (incidentally, you CAN lease some commodities like gold but that is a subject for another time).
As an interesting aside, “investing” in commodities is problematic to us. For a start, when people talk about owning commodities in an investment context – they don’t really mean it. They are probably talking about owning futures contracts and betting that the price will go up. That’s not the sort of real asset we’re interested in. Indeed, futures contracts on commodities like wheat or pork or orange juice were invented to provide certainty to producers of those commodities so that they can better run their farms / plantations. They were never meant to be instruments for financial speculation. But I digress.
Making the distinction between real assets and financial assets is useful from a descriptive sense, but that’s it. The motivation for investing in real assets has nothing to do with the fact that they are “real”, instead the most important thing, as ever, is-that they can contribute to your client objective. This means they can generate positive returns after inflation, taxes and charges, and even better, they can do this in a manner that is uncorrelated with financial assets like bonds and equities. If a real asset can’t contribute to the client objective and bring something to the client portfolio, there’s no point in considering them.
There are plenty of real assets we can access via investment trusts, but which we have no interest in investing in because they are valued too expensively. And this is the crux of the issue. Forget about the label of the asset – whether it’s real or financial. Can that asset deliver on your client objective and can you build a portfolio using those assets that ensures the client objective can be met most of the time?
We own lots of real assets – but the fact that they are “real” is beside the point and completely incidental. We like them because they are cheap. We’d own lots of index-linked gilts if we thought they would deliver a positive real return (locking in -3% isn’t very appealing to us). Or loads of US large cap tech if they were cheap. The point of investment is not to look clever or own “interesting” assets. The point of investing is to help clients grow their wealth in real terms. And the proliferation of investable real assets via the investment trust market is a great thing and is certainly helping us with that objective. The fact that we love doing the due diligence on so many asset classes is a very welcome off-shoot, but we don’t sit around saying, “we need more real assets”!
Ben Conway – Head of Fund Management
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