Global real asset funds
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Global real asset funds
Introduction
The concept of real assets
This paper considers of evaluating the benefits of real assets as a measure to hedge inflation and diversification risk. Assets such as commodities, precious metals, natural resources (namely timberland and farmland), infrastructure, and commercial real estate have more and more being used to improve performance of investors’ portfolios. Send’Or Capital Global Real Asset Fund will invest in real estate by acquiring positions in securities issued by U.S. and non-U.S. real estate companies, including REITS and similar REIT-like entities. Cohen & Steers Real Asset Fund, Inc (2013) describes a real estate company as one that (i) derives at least 50% of its revenue from the ownership, construction, financing, management, or sale of commercial, industrial, or residential real estate and land; or (ii) has at least 50% of its assets in such real estate. They clarify that REITs are companies that own interests in real estate or in real estate related loans or other interests, and their revenue primarily consists of rent derived from owned, income producing real estate properties and capital gains from the sale of such properties. A REIT in the U.S. is generally not taxed on income distributed to shareholders so long as it meets certain tax related requirements, including the requirement that it distribute substantially all of its taxable income to such shareholders. Foreign REITs and entities similar to REIT are organized outside of the U.S have operations, and receive tax treatment similar to that of U.S. REITs in their respective countries.
Direct investments in real assets are quite distinct from traditional asset classes such as public equities and government bonds, e.g. due to a lack of active trading on exchanges and typically long holding periods. In this white paper, we provide some introductory description of three different real asset classes: natural resources (timberland and farmland), infrastructure (specifically investments in energy infrastructure), and commercial real estate. Of these three, only the latter has been an asset class in which large institutional investors such as pension funds have long held major investments, while natural resources and infrastructure have only recently become more prevalent in institutional portfolios (Cremers/Deutche paper 2013)
Inflation is unpredictable, but its risks are known
Even low levels of inflation can have a significant impact on investors’ purchasing power. In January of 2003, a basket of food items consisting of bread, a gallon of milk, and a dozen eggs cost $4.90. Ten years later, those same items cost $6.88, a 40% increase. Over that same period, a gallon of gasoline increased 127% and a gallon of heating oil was up over 175%. 1Over the last decade, inflation may not have been headline news, but prices for many everyday items have increased dramatically, making an impact on investors’ wallets because no one strategy performs in all inflationary environments, the Principal Diversified Real Asset Fund combines multiple strategies and premier managers to target broad inflationary and market concerns.
Gold and silver over time have proven their resilience to inflation. There have been extended periods where gold and silver have lost value though as well, so it is not a foolproof proposition. Everyone likes to point out the peak price of gold that was seen for a brief moment in January 1980 of $850 per ounce and use that as a starting point for showing how gold lost money over the next two or three decades. However, the price of gold in December 1979 was below $500 an ounce and by February 1980 the price was already back below $650. So take those stats with a starting price of gold in 1980 at $850 with a grain of salt. We could just as easily use a starting point of August 1971 with gold at $35 an ounce to show spectacular gains over time.
There are many ways to invest in gold and silver. American eagle bullion coins are one very popular method. Many people like the personal security and feeling of value in their possession by the physical ownership of gold or silver American eagle coins. Taking ownership of physical coins has its risk though. You must securely store these and keep them safe from theft, fire, or other threats. Insurance is an option, however precious metals are inexpensive to insure and many people find that the costs outweigh the risks and find other means to protect their investment. Safety deposit boxes are certainly an option as well and do provide a great deal of security (at a cost).
Another option of gold and silver ownership is through the securities market. There are ETF options available, which give you rights of ownership to gold or silver. These are just “rights” though and you do not physically hold possession of the precious metals. These are paper assets and only as good as the word of the issuing company of the ETF. The advantages include ease of ownership, high liquidity, and not having the direct costs or risks associated with storage (although there are some fees built into the price of the ETF to reflect these costs).
A third option to consider is the ownership of pre-1965 United States circulation quarters, dimes, and half dollars. Prior to 1965 quarters, dimes and half dollars minted and circulated by the US Mint consisted of 90% silver. Kennedy half-dollars continued to be produced at 40% silver content through 1969. These coins still exist today and hoarded by many enterprising individuals. You could potentially even find these in your spare change, although most pre-1965 quarters, dimes and half dollars were pulled from circulation long ago by the hoarders.
Consider a favorite story mine showing the power of precious metals as a protector from inflation. In 1964, a quarter could buy you a gallon of gas. In 2011, gasoline is now over $3.50 a gallon in most locations, however that same 1964 90% silver quarter has a silver content value of $6.20 today (with silver trading at $34.27 an ounce). You could sell that 1964 quarter and buy one and three quarter’s gallons of gasoline today. Is gasoline actually cheaper today than it was in 1964, or is it just that our US dollars have depreciated against the value of precious metals?
Advantages of holding pre-1965 silver coins are the ease of storage and non-attention calling these coins bring. If a thief were to break in your home and found a stash of spare change that was not bagged or marked in a special way, it is very unlikely they would even bother looking twice at them. They are more interested in your flat panel television or other items in your home that are likely covered by your insurance policy. Additionally, in a state of emergency or extreme difficult times, the coins are still considered legal US tender and could be used for purchases. However, they are much more valuable for their silver content as demonstrated with our gasoline example.
There is a large and liquid market for pre-1965 silver coins as well. A quick check on ebay and you will find these coins sell quite well and you can easily list and sell the coins for their silver value or even greater if the coins are in what collector’s consider above average condition. If you go to your local coin shop you will likely get at least somewhat close to the value of the silver content, but the loss could be worth it to some for the convenience of the sale.
Other precious metals and base metals can protect your buying power as well. Platinum, palladium, copper, nickel, etc. all have inflation protection characteristics. I will write a future blog post about the pre-1982 copper penny later. Until then consider your personal inflation rate on what you need to do to protect the buying power of your money over time.
Why they are increasingly popular now
Real assets have been increasing in popularity in the last decade. Cremers (2013) in his report states that energy infrastructure significantly outperformed all other asset classes during 1996-2012.
As a diversification Instrument, Real Assets are a unique class that can provide valuable diversification benefits to any investment portfolio. They are increasingly being used in combination with traditional assets like stocks and bonds; they can hedge overall portfolio long-term risk while increasing upside potential.
Recent markets have shown that it is no longer enough for any investor to be diversified only among traditional asset classes. Every investor’s portfolio has the ability to benefit from an allocation to a diversified real asset strategy, which can reduce risk and enhance returns. The figure above displays the potential benefits investors could have achieved by investing in a diversified combination of real assets (Principal Funds 2013).
Now may be the times to position their portfolios with an investment strategy that can help address economic concerns such as inflation risk, as well as provide additional diversification and enhanced return potential.
As an investor, the author has experienced and witnessed the recent trends in the real estate industry. As the President of Send’Or Capital and having facilitated financing and sourcing real estate products, she felt it was the logical step to take in order to satisfy the needs of the company’s existing investors. Some investors prefer not to have the restriction of illiquidity, which direct capital investment in to physical asset brings with it. Recent difficulties in the US especially in the real estate market proved that diversification was essential to protecting capital.
In order to prove the assumption that a global real asset fund makes sense, primary and secondary research was conducted. The academic data and report in the lit review provide this evidence. In the methodology section, we explain in details the tools and instruments utilized in order to facilitate this research. We provide details description of the process involved in interviewing experience investors. We also elaborate on how we came about obtaining and discerning competitors’ data. We also use this section to explain some of the limitations to capturing the necessary statistics in order to illustrate our point. In the Analysis and Findings chapter of the report, we proceed to summarize what our research demonstrated to corroborate and substantiate our premise. Next, the Fund Structure segment, outlines exactly what Send’Or Capital Global Real Asset Fund is offering, cost, and strategies are. There that the reader will gain a broader understanding of how to access the Fund directly and through other distribution points such as brokers. Finally, in the Conclusion will bring it all together by briefly discussing the value of investing in Real Assets. This section will also allow an opportunity to evaluate the effectiveness of your research programmed and to offer recommendations
5) A literature review to see if real assets demonstrated empirically the claims made for them (inflation hedging etc)
3-Literature Review
In this section, we review the academic evidence to support the theory that investors can diversify and protect their portfolios by using real assets. This simple fact is explained as we examine the effects of returns provided by real assets such as direct real estate, listed real estate (REITs) and commodities. Due to current volatility in the global markets, fund managers are turning to real asset investments to suit their clients’ needs. Many factors bring uncertainty to markets including intra-government conflicts as we have seen in the US recently, threats of war, and inflation risk. These have all played a significant role in the last few years and led to an increase in the use of real assets to protect portfolio returns.
Cohen and Steer (2013) documents and discuss exactly that. They state that many investors are increasingly using real assets to diversify and protect their portfolios and that many large endowments have been increasing investments in alternatives and tangible real asset categories such as commercial real estate and natural resources. They agree with this approach for many types of investors, while advocating for the liquidity of listed securities markets to build these allocations. They use an example highlight the bond market’s vulnerability of the bond to rising interest rates in which the graph their findings should investors begin to rethink their allocations to bonds, given the recent backup in U.S. Treasury yields? We believe so, especially with the Fed’s recent comments about scaling back its asset-purchase program. Based on the improving outlook for the U.S. economy, this so-called tapering could occur earlier than anticipated, possibly during the latter half of this year. There are concerns that these actions will drive fixed-income yields higher—and possibly ends the 30-year bull market. Perhaps it is time to take a cue from the largest university endowments, which have dramatically reduced fixed income allocations over the past decade. In 2002, for example, the Ivy League endowments of Harvard, Princeton, and Yale had about 25% of assets invested in fixed income. However, last year, they held an average of just 6% in bonds, and many other endowments are following suit. The chart below illustrates these allocation trends over the past decade for the 68 university endowments of over $1 billion in size. Many large endowments have been increasing investments in alternatives and tangible real asset categories, such as commercial real estate and natural resources. We agree with this approach for many types of investors, while advocating for the liquidity of listed securities markets to build these allocations. Commercial real estate securities seem well positioned for continued cash-flow growth as interest rates normalize. Especially attractive, in our view, are more cyclical sectors with shorter lease terms and the pricing power to raise rents in the face of rising costs (e.g., hotels and shopping centers). Pricing power is also a characteristic of commodities and natural resource equities in periods of economic growth, which can buoy performance when rates are rising. This was the case in the most recent period of rising U.S. Treasury yields, which occurred during the 49-month period between June 2003 and June 2007. In that period, the annual total returns of the Dow Jones-UBS Commodity Index and the S&P Global Natural Resources Index were 12.5% and 25.6%, respectively; performance was also strong for the FTSE EPRA/NAREIT Developed Real Estate Index, which had an annualized return of 22.7%. (INSERT THE ARGUMENTS THEY USE IN THEIR PAPER, AND THEIR EVIDENCE)
Amenc, Martellini, and Volker (2008) in their paper based on present an empirical analysis of the benefits of alternative forms of investment strategies from an asset-liability management perspective. They used a vector error correction model (VECM) that explicitly distinguishes between short-term and long-term dynamics in the joint distribution of asset returns and inflation, they identified the presence of long-term co-integration relationships between the return on a typical pension fund liabilities and the return of various (traditional and) alternative asset classes. Their results suggest that real estate and commodities have particularly attractive inflation hedging properties over long-horizons, which justify their introduction in pension funds' liability-matching portfolios. They show that novel liability-hedging investment solutions, including commodities and real estate in addition to inflation-linked securities, can be de-signed to decrease the cost of inflation insurance for long-horizon investors. These solutions are shown to achieve satisfactory levels of inflation hedging over the long-term at a lower cost compared to a solution solely based on TIPS or inflation swaps. Overall, our results suggest that alternatives are very useful ingredients for institutional investors facing inflation-related liability constraints. Our empirical analysis focuses on a set of traditional and alternative asset classes. Stock returns are represented by the CRSP value-weighted stock index. Commodities are proxied by the S&P Goldman Sachs Commodity index (GSCI). Real estate investments are represented by the FTSE NAREIT real estate index, which is a value- weighted basket of REITs listed on NYSE, AMEX, and NASDAQ. ( SAY THE PERIOD OF THE ATUDY AND WHICH MARKETS IT COVERED)
Real Asset definition
Given that there are a variety of definitions, we seek to provide a working definition of real assets for the purpose of this document. Real assets are distinct and isolated from financial assets whose value originates from a contractual claim on an underlying asset. They may be real or intangible. Commodities and property are real assets but commodity futures and ETFs including real estate investment trust are considered financial assets whose value depend on an underlying asset. Real assets like land, buildings, and commodities are good long-term inflation hedges due to their physical or tangible nature, which gives them intrinsic value. A brick of gold, for example, has value even in the absence of a paper-based monetary system and could be traded for other valuable goods (Deutche paper/Cremers 2013)
To be positive over time and exceed the rate of inflation
(Attribute the source of this quote?)
Principle Fund (2013) explain that unlike financial assets, real assets are physical, tangible assets like gold, land, equipment, timber, and commodities such as food. According to them, these assets derive their value from what it represents and their intrinsic value comes from what it represents. Although some physical assets, such as land, can be acquired directly, many other real assets are illiquid. However, interests in many real assets may be obtained via share-based investing such as real estate investment trusts (REITs), natural resource stocks, and Master Limited Partnerships (MLPs). Others, like commodities, can be purchased via futures markets and structured notes.
- Investment instruments available- Listed vs. non listed (real assets, precious metals, bonds, money markets, stock s, ETFs)
The fund itself will be unlisted but will explore both listed and unlisted investment opportunities. Those listed would have to meet their respective market requirement for instance in the USA the regulating body is the Securities and Exchange Commission (SEC) and in the United Kingdom the Financial Conduct Authority (FCA) who is the successor of the Financial Service Authorizes (FSA (THE FSA NO LONGER EXISTS IT HAS BEEN REPLACED BYRHE FCA).
Real Estate
Idzorek, Barad, Meier, (2007) discuss the advantages of direct real estate investment as providing the investor the ability to have direct control, the ability to select individual properties and some potential tax-timing benefits. They found that largest investors (large institutions) will likely implement their target allocations with a more heavily weighted direct commercial real estate investment program, while smaller investors will likely do it more with REITs and listed real estate stocks.
Lahey, Akhigbe, Newman, Anenson, (2012) examined the role of real estate and alternative assets in the investment portfolio of defined benefit (DB) pension plans offered by U.S. firms for the period 2002 to 2010. Their empirical results suggest that large, more underfunded DB pension plans are willing to bear the risk of real estate and/or alternative investments in an effort to garner higher returns. Interestingly, for sample of plans over the 2002-2010 periods, the returns for plans opting to invest in real estate but shunning alternative investments are greater than those that follow an opposite strategy. In addition, the returns are higher for plans investing in real estate and/or alternative investments than for plans investing in only debt or equity.
Rehring, (2011), in his article, examines three special characteristics of the real estate
Asset market—high transaction costs, marketing period risk and return predictability—are addressed in analyzing the role of U.K. commercial real estate investments in a mixed-asset portfolio. His results show to favorable horizon effects in risk and return, the allocation to a portfolio with stocks, bonds, and cash increases strongly with the investment horizon. Empirically, he looked at the U.K. market and find that the conditional (i.e., considering return predictability) standard deviation of commercial real estate returns changes with the investment horizon in a similar fashion as it is estimated for stocks. The annualized long-term (20-year) standard deviation of real returns of both asset classes amounts to approximately 60% of the short-term (1-year) risk. A horizon-dependent marketing period risk premium has only a small effect on the volatility of real estate returns. Due to high transaction costs, expected real estate returns, per period, are much higher in the end than in the short run. In portfolio optimizations, the allocation to real estate strongly increases with the investment horizon.
Hristea, (2013), examines the value of real estate in the current economic climate. She explains that economic reality showed that real estate assets value (buildings, land) kept proportions with economic reality over time. A comparison between stock exchange market and the real estate market shows that while a movables investor (investments in stocks, bonds, or life insurance) might lose completely his initial investment, the investments in real estate assets, such as buildings, would keep their quality as goods. It would also keep a value better to resist shocks and thus allowing an increase of the capital. She reports in her search paper that above all the risks the real estate market is a big enhancer of the rise of the national economy. Beyond the obvious benefices brought in time to the investors, the real estate market is an influent environment for the PIB, a source of reduction of unemployment through the creation of jobs in constructions, a source of incomes for the banking institutions and not last, an important contributor to the state budget. It is no wonder that the newest statistics indicate in the last years an important dynamism of the real estate investors in the poorer areas of the Globe. The internationalization of the real estate investments is a good example regarding the new tendencies of the global businesses but real estate markets in most countries are not as organized or efficient as markets for other, liquid investment instruments. Individual properties are unique to themselves and not directly interchangeable, which presents a major challenge to an investor seeking to evaluate prices and investment opportunities. For this reason, locating properties in which to invest can involve substantial work and competition among investors to purchase individual properties may be highly variable depending on knowledge of availability. Information asymmetries are commonplace in real estate markets. This increases transactional risk, but also provides many opportunities for investors to obtain properties at bargain prices. Real estate entrepreneurs typically use a variety of appraisal techniques to determine the value of properties prior to purchase.
According to Cohen and Steer (2013), commercial real estate securities seem well positioned for continued cash-flow growth as interest rates normalize. In their view, this is especially attractive because more cyclical sectors with shorter lease terms and the pricing power to raise rents in the face of rising costs (e.g., hotels and shopping centers). The two main ways of calculating, NPV is with the help of cash flows and discounting them with a risk less discount and second discounting the cash flows at risk-adjusted rate. These procedures enable investors have an estimation of their returns and make the decision for diversifying their portfolio. Due to the volatility in the international markets fund managers are investing in real assets according to the nature of their clients and are able to provide projections for a long period (Cohen & Steers, 2013).
Real Estate Investment Trust (Reit)
Lopez, (2009) a significant portion of the CRE assets in the United States is owned by publicly traded, real estate investment trusts (REITs). Publicly traded REITs are companies that qualify as pass-through entities who pass the majority of their income directly to investors without corporate taxation providing that certain conditions be met. REITs concentrate on buying, developing, and managing commercial real estate assets that generate rental income.
According to Idzorek, Barad, Meier, (2007), a shift is underway within the global commercial real estate asset class. They explain that the advantages of REITs include investor access, lower costs (for most investors), liquidity, independent analysis, corporate governance, and real-time pricing in public capital markets. These advantages create a natural preference for REITs and listed real estate stocks, and over time, a significant amount of direct real estate is likely to be securitized. As REITs and listed real estate stocks continue to grow worldwide, their share of the commercial real estate market will also grow and become more accepted as a method of obtaining exposure to the commercial real estate asset class. The transparent tax treatment of REITs allows investors access to the same cash flow characteristics that were once available only to direct commercial real estate investors. Today, global REITs and listed real estate stocks make commercial real estate available to investors around the world.
Price, (2011), investigates how the performance of REITs may determine the level of holdings in real estate mutual funds. His study combines the process of asset composition of REITs with the REITs’ contribution in real estate mutual fund portfolios. There is a 2% to 3% increase in REIT holdings when the dividend yield increases by 1%. The relationship is strongest during the tech bubble period. This will give the investment advisor a look into management of real estate related assets in their respective portfolios. He mentions that REITs have undergone rapid growth in the few years. In 1990, prior to the Omnibus Budget Reconciliation Act of 1993 that changed REIT ownership rules1; there were about 117 REITs, with an average market capitalization of about $800 million. In 1994, after the Act, there were 130 REITs with an average market capitalization of about $1.3 billion. By 2005, while the number of REITs had declined slightly to 208, the average market capitalization had grown to $5.2 billion, representing a compound annual growth rate of more than 20%. Along with this growth in the REIT, market has been an even greater growth in mutual funds that specialize in REITs. (ACADEMIC ARTICLES NEEDED)
- Commodities
Commodities will be classified with Natural Resources for the reasons listed by Principal Fund (2013): Many commodities, including coal, timber, water, salt, uranium, iron ore, silicon, potash, and rare earth metals, are not traded on futures exchanges or owned in typical equity portfolios. They also provide an opportunity to invest in companies that operate downstream from the resources, such as companies specializing in refining, paper manufacturing, steel fabrication, and petrochemicals.
Cremers (2013) in his paper considered the performance of direct investments in three real asset classes: natural resources (namely timberland and farmland), energy infrastructure, and commercial real estate. Using publicly available data for a period starting in 1978 (for real estate) or 1996 (for infrastructure) and ending in 2012, the main result is that investing in these real asset classes would have provided significant diversification benefits relative to a traditional portfolio consisting of only public equities and government bonds, without evidence of deteriorating overall performance
Cohen and Steer Real Asset Fund Prospectus mentions commodities are assets that have tangible properties and that are used in commerce, such as fuels (e.g., crude oil, natural gas, and gasoline), precious and industrial metals, livestock, and agricultural products. The Braham (2010) makes the case that oil, corn, gold, wheat are all-concrete. He explains that even if the price of oil fluctuates more or less in one trading day, it will never disappear completely.
Buttel (2011) makes a case for commodities by stating that though this asset class was once an obscure corner to the markets it has moved into the mainstream. Thanks mutual funds, exchange traded funds and other vehicles that that easily allow investors to partake in a wide spectrum of investing opportunities of investing opportunities for oil to and gold to wheat and soybeans.
Braham, (2010) feels that some pros see a long-term bull market for oil, grain, and gold. He says historically, commodities have proved a better short-term hedge against temporary inflationary shocks than a good long-term investment. He also explains that since most commodities are priced in US dollars, the best time to buy is when the dollars weakens. This is due to the Feds strategy to increase the money supply dramatically. As the amount a dollar can purchased decreases, commodity prices rise in relative terms.
Akey, (2006) studies if a commodities investment can be both a high-risk adjusted return source and a portfolio hedge risk. While the short term versus long-term distinction is an important consideration for investors attempting to answer the “Why commodities?” question, he feels that the time horizon disconnect is perhaps more important for those investors who have embraced the asset class though by now find themselves asking “How commodities?” He outlines why and how an active commodity portfolio an active commodity portfolio may earn superior absolute or risk-adjusted return relative to passive commodity investments. The largest of the commodity indexes (the Goldman Sachs Commodity Index or GSCI with an estimated $5()-$55 billion in assets linked to it) has produced a compound annual return of 23.78% from January 2002-December 2005. The current attraction to commodities is certainly these high returns. The incremental addition of active commodities exposure to each index produces similar results: Returns increase while risk characteristics decrease; however, correlation to equities also increases. Adding 50% active exposure to the DJ-AIG Index, for example, increases return by more than 70%, decreases volatility by 25%, decreases drawdown by almost 40%, and maintains limited correlation to equities. In a bullish environment, the results of the incremental addition of active commodities exposure to each index are more mixed. In the case of the GSCI, absolute returns decrease a .small amount when adding active exposure, but the commensurate reduction in volatility improves risk-adjusted returns nearly threefold and decreases drawdown significantly. A portfolio that is comprised of 50% GSCI and 50% Active captures 95% of the upside but just 60% of the downside of a 100% passive portfolio, while maintaining negative correlation to the S&P 500.
Poblacion’s (2009) study set out to determine the optimal contract due to the large capital requirements. He explains that when a company is planning to develop a crude oil or natural gas field, the investment is significant and production usually lasts many years; however, the main investment has to be made initially in order for there to be any return (see for example Jahn et al1 or Smit,2 among others). Consequently, the company needs a sell contract that contains clauses including a minimum price to guarantee that the seller will recover the value of the investment