Rather than measuring the diversification potential of real assets using correlation data (which, for private real assets, are rendered virtually useless due to infrequent and biased valuation marks), we asked a different question: How have real assets done when both stocks and bonds underperformed their long-term averages at the same time? These periods represent breakdowns in traditional stock-and-bond diversification, when an allocation to alternative investments could be particularly helpful.
This scenario of joint stock-bond underperformance has occurred in almost one quarter of rolling 12-month periods since the early 1970s.
To capture the return series for private real assets, we must look at a shorter history of data going back to the early 1990s. During this span, simultaneous underperformance was less frequent, representing about 10% of the rolling periods, concentrated mostly in 1993-'94, the late 1990s/early 2000s, and again in 2004-'06. What we found is that when stocks and bonds were below average, real assets generally had solid gains: a basket of listed real assets produced annualized real returns of 7.9% in these periods, compared with stocks at 2.1% and bonds at -1.6%. Notably, these returns for listed real assets were comparable with private real estate and only modestly below timberland and farmland.
Diversification potential is all well and good, but it won't help investors much if the opportunity cost is too high. Over the past two decades, real estate securities, listed infrastructure and natural resource equities have exhibited average inflation-adjusted returns in the 6% to 9% range, generally on par with broad-based equities and similar to private real assets. The exception is commodities, which have had a stretch of subpar returns in recent years (although the full history going back to the 1970s is more constructive). Again, we find no reason to conclude that illiquid real assets are somehow “more real” than their liquid counterparts.
It is clear from historical data that neither listed nor private real assets are dependent on an adverse, 1970s-style inflation scenario to generate attractive full-cycle returns. In fact, the returns discussed above span an era notable for its absence of serious inflation. However, inflation sensitivity is a hallmark of all real asset categories. Whereas stocks and bonds tend to react adversely when realized inflation overshoots expectations, listed and private real assets have generally exhibited positive price sensitivities to inflation surprises. This indicates a tendency for real assets to deliver above-average returns precisely when inflation is likely to weigh on stocks and bonds. One critical point is that no single category under the real assets umbrella can serve as a “silver bullet” that performs across all of the investment criteria noted above. While certain asset classes might look attractive individually, our research shows that a diversified blend of real assets has historically provided the best experience for investors.