Investor interest in “real assets” has risen relentlessly during the financial crisis and its aftermath. By real assets we mean claims on the value of tangible items such as timber, oil, soybeans, copper and the like (as well as the companies that own them) or claims on changes in the value of inflation-linked assets (such as Treasury inflation-protected securities, or TIPS). This interest has been driven by fears of high inflation, triggering a tumble in the value of paper money and financial claims.
Whether we might indeed see such inflation is a discussion for another time, but you don’t need to panic about inflation to want to invest in real assets. For the past several years, we have recommended investments in real assets as a means to obtain the diversification benefits of traditional stocks and bonds as well as potential inflation protection. Remember, tangible real assets are critical components of the global economy that tend to rise in value with increased economic activity. Both developed and developing economies continue to place strong demand on these ever-more-costly-to-obtain and often increasingly rare natural resources making them, we think, attractive investments in their own right.
You don’t need to store soybeans in your garage. Stakes in real assets can be acquired through liquid investments such as the common stock of natural resource, energy or infrastructure companies; master limited partnerships (MLPs); real estate investment trusts (REITs); and various commodity investment strategies. Investors may also take illiquid positions in real assets through private equity, private real estate and royalty funds. Each approach carries distinct risks and offers distinct advantages.
Risks and Rewards
The primary advantages of investing in publically listed securities are liquidity and transparency. Listed equities and ETFs, for example, may be sold on any trading day at the prevailing market price. Mutual funds are not quite as liquid: Investors can sell these securities only at the end of a business day at net asset value, which itself could be either real or estimated. Publically traded securities are handy in other ways. They can typically be used as collateral on loans and generally involve less tax-reporting paperwork than do unregistered securities. In addition, the investment minimum is generally quite low and the range of listed companies is significant, allowing easy diversification across geography and investment types.
Tax issues are very important even when securities are publically traded. For example, some listed securities, such as MLPs and some ETFs, are structured as partnerships and so generate Schedule K-1 tax forms. Similarly, although most mutual funds may distribute tax-free to investors, some must pay corporate taxes at the fund level and thus may be less tax beneficial.
The primary disadvantage of listed real asset securities is their strong correlation with broad markets, which reduces their diversification benefits. While many real-asset investments have recovered from lows reached during the credit crisis, investors should expect ongoing large swings in value as our global economic crisis is far from resolved.
In addition, gaining access to some types of real assets through registered securities can be difficult. Available public vehicles in timber, agriculture and royalties, for example, are few and far between. An investor may get neither as much ultimate return nor as much diversification as would theoretically be possible.
Private Investments: Worth a Closer Look
Private investments may provide access to unusual and smaller, less-publicized opportunities with the potential for higher expected returns. The other side of illiquidity is the ability to invest over a period of years, allowing the managers to take advantage of different investment climates. The managers also have more leeway in managing a private fund, which may enhance the ultimate return. In addition, private investments may benefit from partnership accounting, which increases tax efficiency as both gains and losses flow through to investors.
This is why we consider private securities when constructing real asset strategies. But we remain mindful of the disadvantages. Not everyone can or should invest in private securities. Often illiquid, most private securities have qualification requirements. Because they are not registered, they are not required to provide the same level of transparency that registered securities offer. You may be buying on faith alone, because, even at the end of an often lengthy investment period, the manager may reveal few details of the holdings.
In addition, once committed to investing, you must fully fund the amount you committed. Should you want or need to sell, you may – or may not – be able to find a buyer both willing and eligible to assume your commitment. And if you do find a buyer, the haircut you take on such a secondary market sale may be quite depressing. At the level of annoyance rather than financial risk, private investments generate K-1s, which are often late and frequently complex, almost invariably forcing the investor to file tax extensions and employ a professional tax preparer.
In summary, then, investing in real assets may well be a good idea given your financial situation and aspirations. But how to invest requires balancing a number of issues in a very specific and personal context.
The opinions expressed above are solely those of Contango Capital Advisors and do not necessarily reflect the views of Zions Bancorporation, its affiliates or its management.
IMPORTANT NOTE: Wealth management services are offered through Contango Capital Advisors, Inc.(Contango), a registered investment adviser and a nonbank subsidiary of Zions Bancorporation. Investments are not insured by the FDIC or any federal or state governmental agency, are not deposits or other obligations of, or guaranteed by, Zions Bancorporation or its affiliates, and may be subject to investment risks, including the possible loss of principal value of the amount invested. Some representatives of Contango are also registered representatives of Zions Direct, which is a member of FINRA/SIPC and a nonbank subsidiary of Zions Bank. Employees of Contango are shared employees of Western National Trust Company (WNTC), a subsidiary of Zions Bank and an affiliate of Contango.