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Real Assets

Understand the Concept of Real Assets

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Real Assets

In This Article
  • What is the definition of a real asset?
  • How do real assets differ from financial assets?
  • What are examples of asset types classifying as real assets?
  • What are the benefits of investing in real assets?

Real Assets Definition

A real asset can be described as a tangible asset that possesses value due to being able to produce goods or services.

The purpose of real assets is the generate revenue and profits, so the intrinsic value of a real asset stems from its utility with regards to productivity.

From a broad perspective, all the wealth creation within the economy is thereby determined by real assets and their productive capacity.

There are three main categories of real assets, which are each defined in the table below.

Real Estate
  • Land and properties for residential and commercial purposes, e.g. family homes, housing apartments, commercial buildings, offices, malls, storage units, and warehouses.
Infrastructure
  • Systems and networks that facilitate the transportation, storage, and distribution of goods and services, e.g. roads, airports, railroads, sewer systems, power lines, subways, pipelines, and towers.
Commodities
  • Resources used in commerce and often a necessary input for the production of another type of good, e.g. oil, natural gas, corn, soybeans, precious metals like gold and silver.

Real Assets vs Financial Assets

Financial assets represent claims against an underlying company, so the value of financial assets depends on the underlying asset, e.g. a corporation that raised capital through selling shares or issuing debt.

The relationship between real assets and financial assets is that financial assets represent claims to the income produced by real assets.

Land and machinery are real assets, whereas stocks and bonds are financial assets.

  • Issuer: Financial assets appear on the liabilities and equity side of the balance sheet.
  • Owner: Financial assets appear on the assets side of the balance sheet.

One drawback to real assets compared to financial assets is that real assets are less liquid because the marketplace has less volume and trading frequency.

Thus, the price reflected on real assets tends to be a rough estimate with a much larger spread than for financial assets, i.e. there is less market efficiency.

Conversely, financial assets trade hands each day, and the price reflected can be updated in “real-time.”

The valuation of real and financial assets shares many similarities, such as being largely related to their ability to produce cash flows, but real assets are recorded at their historical value and reduced by depreciation, if applicable.

On the other hand, the market value of financial assets is often readily available to observe.

Real Assets Benefit – Inflation Hedging

One distinct benefit of real assets is that such investments can function as a hedge against inflation.

Historically, real assets have fared better than other asset classes during periods of inflation as well as during economic downturns.

Even if the valuation of real assets were to drop, the widespread view is that real assets are substantially more likely to recover once the economy normalizes.

The same cannot be said about equities and debt securities – particularly riskier instruments such as derivatives – which can effectively be wiped out and lose their value entirely.

For instance, stocks that represent ownership stakes in a company could become worthless, or a corporate can default on its bonds.

Of course, the value of real assets can fluctuate substantially during recessions, but there is typically a certain dollar amount of value tied to the asset at all times.

For example, many real assets saw steep declines in value during the housing crisis, yet the period was largely temporary as pricing eventually recovered – but a significant number of financial assets saw far more volatility and were unable to withstand the market crash.

Then, during periods of economic growth, the value of real assets also rises – meaning that real assets mitigate losses during recessionary periods yet still benefit from the upside during expansionary cycles.

Portfolio Diversification with Real Assets

The relative detachment from the equities market and mitigation of inflationary risk serve as another benefit to investing in real assets.

Real assets are oftentimes utilized for purposes of diversification, especially considering their demand tends to be inelastic.

Moreover, real assets portray inelastic demand because houses are necessary as consumers will always need a home for shelter, to sleep in, etc.

As another example, farmland is used for agriculture and the production of crops, which is an essential part of human life.

Given the historically low correlation to the equities and bonds markets, the inclusion of real assets within a portfolio can protect against unexpected downturns and provide more diversification, improving a portfolio’s risk-adjusted returns.

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