What a Portfolio Might Look Like After Adding a Pinch of Real Assets

In December 2015, S&P Dow Jones Indices launched the S&P Real Assets Index, the first index of its kind, which is designed to measure global property, infrastructure, commodities, and inflation-linked bonds, using liquid and investable component indices that track public equities, fixed income, and futures.

The S&P Real Assets Index includes global infrastructure (35%), property (25%), natural resources (35%), and inflation-linked bonds (5%), using stocks (50%), bonds (40%), and futures (10%). It is constructed as an index of indices, using the components and weights shown in Exhibit 1.

Why Use Real Assets?

The two main reasons market participants might consider using real assets are diversification and inflation protection. The S&P Real Assets Index design incorporates both equities and fixed income to more fully represent companies, and it adds commodity futures for more direct exposure to natural resources. The result is that market participants may achieve more diversification and inflation protection than with just equities or with any single asset inside the index.

As shown in Exhibit 2, the S&P Real Assets Index has provided relatively strong inflation protection, with an inflation beta of 4.46, as measured by monthly and year-over-year returns of the index and the CPI, compared with 2.4 for the S&P 500® and the negligible inflation protection of the S&P U.S. Aggregate Bond Index. Inflation beta can be interpreted as a 1% increase in inflation resulting in a 4.46% increase in the return of the S&P Real Assets Index.

Real assets are moderately correlated to each other, since their underlying characteristics are alike in many ways, and, while they have a strong correlation to the S&P 500 (83.0%), they have a more modest correlation to the S&P U.S. Aggregate Bond Index (28.1%). In addition, including real assets in a portfolio offers access to a larger spectrum of assets.

Exhibit 3 depicts two hypothetical portfolios—one with an allocation of 60% to equity and 40% to bonds, and the second with a 50/40/10 allocation to stocks, bonds, and real assets, respectively.

While the annualized return for the one-year period dropped slightly from 14.0% for the equity/bond portfolio to 12.9% for the portfolio that includes real assets, the annualized risk declined as well. The numbers are not mediocre, considering the historical drawdown natural resources have suffered over the past 10 years and the rally of U.S. equities in 2017. It is important to note that analysis up until the end of 2015 showed that the Sharpe ratio increased from 0.47 for the equities benchmark to 0.68 for the equity/bond portfolio and to 0.7 for the portfolio that included real assets.

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