Etikett: real assets

FlexShares: Expectations For Real Assets

FlexShares: Expectations For Real Assets

This is an excerpt from FlexShares’ research paper on Expectations for Real Assets. Get the full paper here.

Expectations For Real Assets

In any market environment, we believe that real assets should be an essential element of every investment portfolio. Growing numbers of institutional investors have steadily increased their real asset allocations over the past few decades. We believe investors are looking for what real assets can offer: the potential for income, gains and capital preservation in an unclear global environment.

Investors continue to benefit from innovation within a variety of investment vehicles that focus on real assets. Furthermore, strong demand for real assets is being met with an unprecedented supply of opportunities for investment, and we believe trends indicate that it will continue to grow. The Real Assets classification (e.g., timber, water, infrastructure, natural resources, etc.) is continually evolving, influenced not only by new asset types, but also regulatory and issuance changes.

Defining The Asset Class And Its Potential

Real assets—which we define as real estate, infrastructure and natural resources—form the pillars of the global economy. As such, these classifications are inherently tied to global developments, inflation and other macroeconomic trends. Notably, the cash flows that historically have been produced by real assets can be valuable in times of both economic expansion and contraction. Real assets represent physical assets that are often linked to inflation—a favorable characteristic as potential demand rises in periods of economic expansion.

At the same time, increasing demand for the goods and services that real assets provide may be relatively predictable and inelastic (insensitive to changes in price or income), which can be helpful in periods of economic contraction.

While cash-flow stability has historically been characteristic of real asset investments, the fundamentals that drive the cash flows are distinct. As such, real assets can provide an effective way to enhance portfolio diversification beyond traditional stock and bond allocations.

Portfolio Diversification

Real asset returns have historically had low correlations to traditional equity and fixed-income investments. Our findings suggest they can provide an effective way to enhance the diversification of a traditional stock and bond portfolio. Individual real asset categories have also shown low correlations with each other—consequently investors may be able to diversify further by investing in more than one real asset class.

As highlighted in the chart below, the correlations of real estate with infrastructure and natural resources are 0.85 and 0.62, respectively. The return streams of two assets having a correlation of 1.00 would be perfectly correlated. These measures are relatively moderate because the drivers behind the returns of these categories are distinct.

Consider natural resource pricing, which for some assets, like timber, is highly dependent on short-term factors such as climate, temperature and water supply. In contrast, the cash flows from some infrastructure assets, such as toll roads, tend to rise with an expanding economy, while those derived from more essential services, such as utilities, tend to be more highly regulated, and consequently during times of economic weakness tend to have more locked-in levels of usage pricing.

Capital Appreciation Potential

Our research has shown that both income return and capital appreciation represented meaningful amounts of the historical total returns generated by real assets. Historically, many of these hard assets have tended to be long term and increase in value over time as replacement costs rise and operational efficiencies are achieved.

For many investors, this scenario may be visualized within their own daily experience as they observe the leasing of vacant space, the climb of toll road fees, the rising use of energy or increases in lumber prices. We believe that income from real-asset-related investments may help protect value on the downside, while operational efficiencies may enhance value on the upside.

Potentially Higher Risk-Adjusted Returns

Adding real assets may also enhance the risk-adjusted returns* of a mixed-asset portfolio. The chart below shows the various historical Sharpe ratios of the three real asset categories in comparison to stocks and bonds. The Sharpe ratio is a measure of return per unit of risk, which indicates whether an investment’s return sufficiently rewards investors for the level of risk assumed (the higher the Sharpe ratio, the greater the level of risk-adjusted performance).

For example, the 10-year Sharpe ratio for infrastructure as defined in the chart below is 0.214, which means that an investor should have a greater risk-adjusted return in comparison to an investment in real estate and in comparison to a Treasury bond which has a Sharpe ratio of zero. Only when an investor compares one investment’s Sharpe ratio with that of another investment can the investor get a feel for the return versus the relative amount of risk they can expect to take to achieve that return.

While real assets tend to retain value during economic downturns and contribute to value creation during economic upturns, performance generally lacks drastic movements in either direction. This potential performance stability may provide investors with portfolio benefits in a variety of market environments.

Implementing The Real Assets Portion Of A Portfolio

A number of considerations should be taken into account whenbuilding a portfolio of real assets. One approach for the initial structure isto define the investor’s objectives in terms of yield versus growth-orientedstrategy and sensitivity to the impact of inflation.

For the Yield Investor, a real assets strategy may emphasizeincome-oriented but inflation-sensitive investments that generate potentialsteady cash flows.

For the Growth Investor, a real assets strategy mayseek broader exposure to natural resources to help pursue a growth objective.

For the Growth Investor, a real assets strategy mayseek broader exposure to natural resources to help pursue a growth objective.

Building a real asset portfolio is a process that requires multiple considerations in terms of planning, implementation and monitoring. Real assets can play a fundamental role in a portfolio, depending on an investor’s objectives. Given the current low-yield environment, along with the potential diversification that real assets have historically provided, we believe that investors should consider them in order to create a well-diversified portfolio.

*Risk-adjusted return refines an investment’s return by measuring how much risk is involved in producing that return.

This is an excerpt from FlexShares’ research paper on Expectations for Real Assets. Get the full paper here.

Real Assets Fueled by Energy

Real Assets Fueled by Energy

The VanEck Vectors Real Asset Allocation ETF (RAAX) uses a data-driven, rules-based process that leverages over 50 indicators (technical, macroeconomic and fundamental, commodity price, and sentiment) to allocate across 12 individual real asset segments in five broad real asset sectors. These objective indicators identify the segments with positive expected returns. Then, using correlation and volatility, an optimization process determines the weight to these segments with the goal of creating a portfolio with maximum diversification while reducing risk. The expanded PDF version of this commentary can be downloaded here.

April Performance Summary

The VanEck Vectors Real Asset Allocation ETF (RAAX) launched, on April 9, into a period of strong performance for real assets. RAAX performed well on both an absolute and relative basis. Through April, in the first 16 days of its life, RAAX returned +2.98% based on net asset value versus +2.41% for its benchmark, the Blended Real Asset Index, which is comprised of an equally weighted blend of the returns of Bloomberg Commodity Index, S&P Real Assets Equity Index, and VanEck Natural Resources Index*. Equal weightings are reset monthly.

Total Returns (%) as of April 30, 2018
1 Mo† YTD† 1 Year Life
(04/09/18)
RAAX (NAV) – – – 2.98
RAAX (Share Price) – – – 3.26
Blended Real Asset Index* – – – 2.41
Total Returns (%) as of March 31, 2018
1 Mo† YTD† 1 Year Life
(04/09/18)
RAAX (NAV) – – – –
RAAX (Share Price) – – – –
Blended Real Asset Index* – – – –

The table presents past performance which is no guarantee of future results and which may be lower or higher than current performance. Returns reflect temporary contractual fee waivers and/or expense reimbursements. Had the ETF incurred all expenses and fees, investment returns would have been reduced. Investment returns and ETF share values will fluctuate so that investors’ shares, when redeemed, may be worth more or less than their original cost. ETF returns assume that distributions have been reinvested in the Fund at NAV.

†Returns less than a year are not annualized.

Expenses: Gross 0.81%; Net 0.74%. Expenses are capped contractually at 0.55% through February 1, 2020. Expenses are based on estimated amounts for the current fiscal year. Cap exclude certain expenses, such as interest, acquired fund fees and expenses, and trading expenses.

RAAX’s positioning was moderately defensive in April, and it was fully invested across commodities, natural resource equities, and Master Limited Partnerships (”MLPs”). The largest real asset investments were in diversified commodities (30%), gold bullion (20%), and agribusiness equities (20%).

May Positioning: Fully Invested and Mostly Bullish

RAAX remains fully invested across commodities, natural resource equities, and MLPs. As they were at launch, the largest weightings remain in diversified commodities (30%), gold bullion (20%), and agribusiness equities (20%). However, its allocation to gold equities now stands at 10%, increasing overall gold exposure to 30%.

We are bullish on most real assets. Based on the model’s analysis, diversified commodities, gold, agribusiness equities, MLPs, steel equities, oil services equities, and unconventional oil and gas equities are all well positioned to perform. We are bearish on Real Estate Investment Trusts (REITs), infrastructure, base metal equities, and coal equities.

Asset Class Weights

Source: VanEck. Data as of May 2, 2018.

This month we increased our exposure to gold equities and removed our exposure to coal equities. Another notable point is that we are bearish on two interest rate sensitive sectors, REITs and infrastructure, as interest rates continue to rise.

Remember, RAAX only invests in asset classes that the model is bullish on, and the weightings themselves are not an indication of conviction but a byproduct of a quantitative process that seeks to maximize diversification and minimize volatility. Let’s take a look at some of the reasons why RAAX maintains a bullish or bearish position on certain asset classes.

Gold

The model remains bullish, and overall exposure increased based on the portfolio diversification benefits that gold provides. Gold prices have been flat this year, but the precious metal has provided stability during periods of broad market stress.

Cumulative Growth of $10,000 of Gold and S&P 500 Index in 2018

Source: FactSet; Bloomberg. Data as of May 2, 2018. Past performance is no guarantee of future results. Investors cannot invest directly in an index.

Oil Services Equities

Research conducted here at VanEck has identified that oil price and the S&P 500 Index can be used to explain most of the performance of oil services stocks historically. Using these variables to generate an expected return for oil services stocks, we can look at the difference between this and the actual return of oil services stocks. Right now, based on these variables, oil services stocks are trading at a substantial discount, and the chart below shows that oil services stocks haven’t been this cheap since 2001.

Performance Variance of Oil Servicers and Key Independent Variables

Source: VanEck; FactSet; Bloomberg. Data as of April 2018. Past performance is no guarantee of future results. Oil servicers measured by the MVIS U.S. Listed Oil Services 25 Index. Investors cannot invest directly in an index.

The model remains bullish on oil services stocks. Key bullish indicators include strong oil prices, reasonable volatility in oil services equities, and strong demand for natural gas. The chart below shows that oil prices are up 14.83% this year through April.

Cumulative Growth of $10,000 of Crude Oil in 2018

Source: FactSet. Data as of April 30, 2018. Past performance is no guarantee of future results. Oil measured by West Texas Intermediary (WTI) oil price. Investors cannot invest directly in an index.

Coal Equities

At launch, RAAX had a small weighting to coal, but in May, this exposure was completely eliminated based on falling coal equity prices and weakening supply and demand data. Below is our economic composite for coal. It turned bearish at the end of April due to declining demand for coal in the U.S. and China, and declining production in the U.S.

Coal Economic Indicator Composite

Source: VanEck. Data as of April 30, 2018. Past performance is no guarantee of future results. Coal equities measured by MVIS Global Coal Index. Investors cannot invest directly in an index.

A Closer Look at the What, When, and How

Step One: What to Own

The aphorism ”a rising tide lifts all boats” is appropriate here. April was a great month to invest in real assets. Each real asset in our investment universe and the approximated holding period return of the underlying index is listed below. The assets that we were bearish on are shaded.

Holding Period Return
April 10 – April 30, 2018

Gold Equities 1.42% Oil Services Equities 13.97%
Agribusiness Equities 1.22% Unconventional Oil & Gas Equities 12.36%
Coal Equities -1.78% Global Metals & Mining Equities 4.65%
Gold Bullion -1.56% Diversified Commodities 3.60%
MLPs 6.08% REITs 1.53%
Global Infrastructure 1.53% Steel Equities 7.42%

Source: Bloomberg; FactSet. Data as of April 30, 2018. Past performance is no guarantee of future results. Investors cannot invest directly in an index.

Step Two: When to be Invested

We were fully invested in April. This was the right call as real asset investments rallied. RAAX begins to raise a cash position when five or more assets become bearish. This is typically indicative of a systemic market event. RAAX has not raised cash since it launched.

Step Three: How to Allocate

Capital is allocated amongst assets on which the model is bullish on using an optimization process designed to maximize our diversification and minimize our volatility. In April, this resulted in a 50% exposure to commodities, a 45% exposure to natural resource equities, and a 5% exposure to MLPs. RAAX’s allocation in May has not changed drastically.

Monthly Asset Class Changes

Asset Class May-18 Apr-18 Change
Gold Equities 10% 5% 5%
Diversified Commodities 30% 30% 0%
Agribusiness Equities 20% 20% 0%
Gold Bullion 20% 20% 0%
Limited Partnerships 5% 5% 0%
Service Equities 5% 5% 0%
Cash 0% 0% 0%
Unconventional Oil & Gas Equities 5% 5% 0%
Steel Equities 5% 5% 0%
Estate Investment 0% 0% 0%
Global Infrastructure 0% 0% 0%
Metals and Mining Equities 0% 0% 0%
Coal Equities 0% 5% -5%

Source: VanEck. Data as of May 2, 2018.

Additional Resources

IMPORTANT DISCLOSURE

Please note that the information herein represents the opinion of the author, but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.

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The Blended Real Assets Index consists of an equally weighted blend of the returns of Bloomberg Commodity Index, S&P Real Assets Equity Index, and VanEck® Natural Resources Index. Equal weightings are reset monthly. The S&P Real Assets Equity Index measures the performance of equity real return strategies that invest in listed global property, infrastructure, natural resources, and timber and forestry companies. The VanEck Natural Resources Index is a rules-based index intended to give investors a means of tracking the overall performance of a global universe of listed companies engaged in the production and distribution of commodities and commodity-related products and services. Sector weights are set annually based on estimates of global natural resources consumption, and stock weights within sectors are based on market capitalization, float-adjusted and modified to conform to various asset diversification requirements. U.S. Equities: The S&P 500® Index is widely regarded as the best single gauge of large-cap U.S. equities. The index is a float-adjusted, market-cap-weighted index of 500 leading U.S. companies from across all market sectors. Agribusiness Equities: The MVIS Global Agribusiness Index is a modified market cap-weighted index tracks the performance of the largest and most liquid companies in the global agribusiness segment. Its unique pure-play approach requires that companies have to generate at least 50% of their revenues from agri-chemicals and fertilizers, seeds and traits, from farm/irrigation equipment and farm machinery, from agricultural products (incl. Grain, tobacco, meat, poultry and sugar), aquaculture and fishing, livestock, plantations and trading of agricultural products. Coal Equities: The MVIS Global Coal Index is a modified market cap-weighted index tracks the performance of the largest and most liquid companies in the global coal segment. Its unique pure-play approach requires that companies have to generate at least 50% of their revenues from coal operation (production, mining and cokeries), transportation of coal, from production of coal mining equipment as well as from storage and trade. Gold Equities: The NYSE Arca Gold Miners Index is a modified market capitalization-weighted index composed of publicly traded companies involved primarily in the mining for gold. The Index is calculated and maintained by the New York Stock Exchange. MLPs: The Solactive MLP & Energy Infrastructure Index tracks the performance of MLPs and energy infrastructure corporations. Oil Service Equities: The MVIS U.S. Listed Oil Services 25 Index is intended to track the overall performance of U.S.-listed companies involved in oil services to the upstream oil sector, which include oil equipment, oil services, or oil drilling. Unconventional Oil & Gas Equities: The MVIS Global Unconventional Oil & Gas Index is intended to track the performance of the largest and most liquid companies in the unconventional oil and gas segment. The pure-play index contains only companies that generate at least 50% of their revenues from unconventional oil and gas which is defined as coal bed methane (CBM), coal seam gas (CSG), shale oil, shale gas, tight natural gas, tight oil and tight sands. Global Metals & Mining Equities: The MSCI ACWI Metals and Mining Index is composed of large and mid cap stocks across 23 Developed Markets countries and 24 Emerging Markets countries. All securities in the index are classified in the Metals & Mining industry (within the Materials sector) according to the Global Industry Classification Standard (GICS®). Commodities: The DBIQ Optimum Yield Diversified Commodity Index Excess Return is an index composed of futures contracts on 14 heavily traded commodities across the energy, precious metals, industrial metals and agriculture sectors. Steel Equities: The NYSE Arca Steel Index is a modified market capitalization weighted index comprised of publicly traded companies involved primarily in the production of steel products or mining and processing of iron ore. REITs: The MSCI US Investable Market Real Estate 25/50 Transition Index is designed to capture the large, mid and small cap segments of the U.S. equity universe. The Index will transition completely from the starting MSCI US REIT Index into the MSCI US IMI Real Estate 25/50 Index over a specified period. Infrastructure: The S&P Global Infrastructure Index is designed to track 75 companies from around the world chosen to represent the listed infrastructure industry while maintaining liquidity and tradability. To create diversified exposure, the index includes three distinct infrastructure clusters: energy, transportation, and utilities.

An investment in the Fund may be subject to risks which include, among others, fund of funds risk which may subject the Fund to investing in commodities, gold, natural resources companies, MLPs, real estate sector, infrastructure, equities securities, small- and medium-capitalization companies, foreign securities, emerging market issuers, foreign currency, credit, high yield securities, interest rate, call and concentration risks, all of which may adversely affect the Fund. The Fund may also be subject to affiliated fund, U.S. Treasury Bills, subsidiary investment, commodity regulatory, tax, liquidity, gap, cash transactions, high portfolio turnover, model and data, management, operational, authorized participant concentration, absence of prior active market, trading issues, market, fund shares trading, premium/discount and liquidity of fund shares, and non-diversified risks. The Fund’s assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.

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The potential benefits of real assets in a portfolio

The potential benefits of real assets in a portfolio

ETF Securities Portfolio Insights – The potential benefits of real assets in a portfolio

Highlights

  • Up 1.4% since the end of 2015, the surge in US inflation benefitted most to commodities, up 16.3% on average, followed by natural resources stocks with 6.2%.
  • Following its rally in 2017, the upside potential of equities is questioned for 2018. Our simulated real asset portfolio allows for higher diversification and lower downside risk.
  • Based on historic simulations, an allocation of 20% in the real asset portfolio from a portfolio of 60% equities and 40% bonds increased the Sharpe ratio to 0.58 from 0.54 for the 60/40 benchmark.

In November 2016, we published an article showing how a portfolio of real assets would benefit from a rising inflation environment and improve the Sharpe ratio of a traditional portfolio of equities and bonds. In this note, we are looking back at how the simulated portfolio has performed and provide an analysis of the inflation situation for the year ahead.

Inflation over the past two years

Headline inflations for the US, UK and EU jumped by 1.8% on average since the end of 2015, with the UK reaching the highest level at 3% in December 2017. Core inflations, on the other hand, were mixed. In the UK, core inflation rose 1.1% since December 2015 while EU core inflation was flat and US core inflation fell. This highlights the substantial contribution of the food and energy component in the headline inflation rally, up 1.7% for the UK and the US and 1.2% for the EU.

So far, out of the major central banks, only the US Federal Reserve (Fed) has started tightening its monetary policy and increase interest rates. The European Central Bank (ECB) and Bank of England (BOE) remain on a wait and see mode as both economies remain subject to substantial uncertainties amidst Brexit. While markets have priced in the Fed’s three rate hikes for 2018, we believe they are still underestimating the potential of a policy mistake in a situation where US inflation overshoots and the economy overheats. With inflation in the US, UK and EU highly correlated to each other, we believe headline inflation will likely stabilise around their current levels for 2018.

Interestingly, half of the top 20 performers since the end of 2015 are equity stocks while the other half, with the exception of one, belongs to commodities and more specifically metals for the most part. Mining stocks have seen the best performance, up 133% non-annualised, followed by palladium (90%) and the basket of industrial metals (56%). Miners saw their earnings rise again after mid-2016. Capex growth also turned positive, potentially signalling the beginning of a new business cycle that could last for the next two to three years.

However, data since 1991 show that…

Among the real assets that perform best when US, EU and UK inflation rises, commodities represent nearly 40%, while infrastructure and real estate represent 30% and 17% respectively. Natural resources stocks and inflation-linked bonds making up for the remaining 13%.

Interestingly, the same analysis with EU inflation shows that inflation benefits mostly to infrastructure and real estate assets while rising UK inflation would push inflation-linked bonds to the top five.

The simulated real asset portfolio

The real asset portfolio we created in November 2016 has 10 constituents weighted equally: 3 baskets of commodities (broad, energy and agriculture), gold, platinum, global REITs and global real estate stocks, US energy MLPs, global infrastructure stocks and cash.

Since November 2016, the simulated real assets portfolio continues to lead inflation as illustrated below. Recent trend of the portfolio returns suggests that the inflation rally is likely over, remaining around its current level in the near term.

Equity as an asset class had an strong year in 2017, supported by positive economic data across the world and there are several indicators that the market has confidence that it will continue. The MSCI World index, used as a proxy for equities, rose by 33% since the end of 2015 compared to 7.7% for the bond index (the Barclays Capital Global Bond) and 17% for the simulated real assets portfolio. We, however, observe that overall, the real assets portfolio is less volatile than the MSCI World index and therefore has a better risk-adjusted return of 0.34 versus 0.30 for the equity index.

Starting from January 2018, we are replacing the basket of agriculture with the basket of industrial metals in order to reflect our bullish view on the sector for 2018. We had our call right for 2017 and we believe that metals with industrial applications will continue to benefit from rising economic activities across the world and more specifically from emerging markets.

Real assets contribution to a simulated portfolio of equities and bonds

As a reminder, by adding 20% of a portfolio of 60% equities and 40% bonds in the simulated real assets portfolio, the resulting simulated portfolio with real assets has 50% in equities, 30% in bonds, 10% in commodities, 4% in real estate, 4% in infrastructure and 2% in cash. Both portfolios rebalance once a year in January.

Following the recent equity rally, the simulated portfolio with real assets is underperforming the 60/40 benchmark by 0.2% per year since 2006. It is, however, less volatile, provides better protection from the downside risk and recovers faster to its previous peak. As a result, the simulated portfolio with 20% in real assets is better diversified than the benchmark, improving the Sharpe ratio from 0.54 with the 60/40 benchmark to 0.58

For more information contact:

Catarina Donat Marques
ETF Securities (UK) Limited
T +44 20 7448 4386
E catarina.donatmarques@etfsecurities.com

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