Why “Real Assets” Offer Real Value to Investors

Investing in securities that have exposure to tangible assets like infrastructure, real estate and natural resources can help you hedge against inflation and stabilize your portfolio in fluctuating markets.

Key Takeaways

• Persistent inflation and a resilient economy could spur the Federal Reserve to keep interest rates elevated, which could weigh on some stocks.
• Exposure to real assets can help investors hedge against inflation and diversify their portfolios while generating predictable income streams.
• Investors can explore opportunities in infrastructure, real estate and natural resources that may benefit from economic growth trends.

Stocks and funds that offer investors exposure to “real assets”—that is, tangible assets like infrastructure, real estate and natural resources, whose value is linked to their physical attributes—may be appealing in an environment of solid economic growth, persistent inflation and higher interest rates.

That’s the scenario investors face today. The U.S. economy saw an unexpected surge in the first half of 2023, growing an annualized 2%, and current indicators point to continued solid growth. However, inflation is proving sticky, amid a tight U.S. labor market, low housing supply and resurgent energy prices. Those price pressures are prompting the Federal Reserve to keep interest rates aloft for longer than previously expected. Higher rates, in turn, could weigh on some U.S. equity valuations and leave today’s richly valued benchmark stock indices vulnerable.

Here’s why exposure to real assets could make sense for investors under those circumstances.

Three Reasons to Consider Real Assets

It is possible for investors to hold real assets in their portfolios – for instance, by purchasing gold or buying a share of a building – but it can be more difficult and potentially more risky than purchasing stocks or funds that offer exposure to real assets. Doing so offers a number of potential benefits:

• A hedge against inflation: Real assets tend to increase in value along with inflation, as they contractually or directly pass on higher prices to consumers, allowing investors to keep pace with inflation.

• Potential for competitive returns: First, stocks and funds with exposure to real assets can generate a consistent income stream for investors, regardless of the economic environment or short-term market fluctuations. In addition, real assets may outperform during periods of higher “nominal” economic growth (or the economic growth rate before being adjusted for inflation).
  

• Diversification potential: Stocks and funds with exposure to real assets have traditionally had low correlations to other stocks and to each other, meaning their value does not tend to closely track the ups and downs of these other assets. Should traditional investments decline, for example, certain real assets may help provide stability and limit overall losses in a portfolio.

How to Invest in Real Assets Today

While there are many securities with exposure to real assets, we see select opportunities in three areas that may benefit from economic growth trends.

Thanks to the 2022 Inflation Reduction Act, along with the 2021 Infrastructure Investment and Jobs Act, U.S. businesses across the Energy, Industrials, Materials and Utilities sectors are positioned to take advantage of hundreds of billions of dollars in new infrastructure spending. We suggest investors look for high-quality utility companies that are prioritizing clean energy projects, such as nuclear, hydrogen and wind-power generation, which may make them eligible for potentially lucrative new tax credits and government subsidies. In addition, investors may want to consider gaining broad exposure to U.S.-based Industrials and Materials, as those sectors could benefit from increased spending on aggressive domestic investment agendas that seek to “re-shore” operations back on U.S. soil. Additionally, after pandemic disruptions, companies are re-evaluating their supply chains’ resilience and considering capital investments that may further benefit those sectors.

Although recent troubles in commercial real estate warrant caution, investors can find compelling opportunities in real estate investment trusts (REITs) that are poised to capitalize on the rise of artificial intelligence (AI), such as data-center REITs. Because state-of-the-art generative AI requires massive amounts of data storage and processing power, data-center REITs may offer both attractive growth potential and high dividend yields as AI plays a growing role across the economy.

This category includes companies that produce commodities like oil, natural gas, precious metals and agriculture. Within energy, some companies focused on oil and natural-gas exploration, drilling and extraction are attractively valued today and may benefit from robust demand alongside continued constraints on the global supply of crude. In addition, businesses focused on certain types of natural-gas exports may offer robust cash flow in the form of dividends or special distributions, which can help investors mitigate the risk of price fluctuations and achieve predictable revenue.

The Importance of Being Selective

Real assets are not without risk, and this includes stocks and funds with exposure to them. When evaluating potential investments, consider factors such as their sensitivity to economic growth, the impact of interest rate changes, potential unfavorable regulatory developments and the risk of long-term shifts in demand. Be selective and choose companies with strong balance sheets, reasonable valuations and attractive dividend yields.

Ask your Morgan Stanley Financial Advisor how your portfolio may benefit from actively managed exposure to real assets. Your Financial Advisor can help you access opportunities to invest in stocks and funds with exposure to real assets that our strategists believe may generate strong performance through varied market environments. For example, you may want to consider reviewing the Morgan Stanley Global Investment Office’s Real Assets Equity Income Model portfolio with your Financial Advisor.

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Disclosures:

Index Definitions

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

For index, indicator and survey definitions referenced in this report please visit the following: https://www.morganstanley.com/wealth-investmentsolutions/wmir-definitions

Hypothetical Performance

General: Hypothetical performance should not be considered a guarantee of future performance or a guarantee of achieving overall financial objectives. Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Hypothetical performance results have inherent limitations. The performance shown here is simulated performance not investment results from an actual portfolio or actual trading. There can be large differences between hypothetical and actual performance results.

Despite the limitations of hypothetical performance, these hypothetical performance results may allow clients and Financial Advisors to obtain a sense of the risk / return trade-off of different asset allocation constructs.

Investing in the market entails the risk of market volatility. The value of all types of securities may increase or decrease over varying time periods.

This analysis does not purport to recommend or implement an investment strategy. Financial forecasts, rates of return, risk, inflation, and other assumptions may be used as the basis for illustrations in this analysis. They should not be considered a guarantee of future performance or a guarantee of achieving overall financial objectives. No analysis has the ability to accurately predict the future, eliminate risk or guarantee investment results. As investment returns, inflation, taxes, and other economic conditions vary from the assumptions used in this analysis, your actual results will vary (perhaps significantly) from those presented in this analysis.

The assumed return rates in this analysis are not reflective of any specific investment and do not include any fees or expenses that may be incurred by investing in specific products. The actual returns of a specific investment may be more or less than the returns used in this analysis. The return assumptions are based on hypothetical rates of return of securities indices, which serve as proxies for the asset classes. Moreover, different forecasts may choose different indices as a proxy for the same asset class, thus influencing the return of the asset class.

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value. Bonds are subject to interest rate risk, call risk, reinvestment risk, liquidity risk, and credit risk of the issuer.

Investing in foreign markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and domestic and foreign inflation rates, which can be volatile and may be less liquid than other securities and more sensitive to the effect of varied economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.

Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.

Companies paying dividends can reduce or cut payouts at any time.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Investing in small- to medium-sized companies entails special risks, such as limited product lines, markets and financial resources, and greater volatility than securities of larger, more established companies.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

Physical precious metals are non-regulated products. Precious metals are speculative investments, which may experience short-term and long-term price volatility. The value of precious metals investments may fluctuate and may appreciate or decline, depending on market conditions. If sold in a declining market, the price you receive may be less than your original investment. Unlike bonds and stocks, precious metals do not make interest or dividend payments. Therefore, precious metals may not be appropriate for investors who require current income. Precious metals are commodities that should be safely stored, which may impose additional costs on the investor. The Securities Investor Protection Corporation (“SIPC”) provides certain protection for customers’ cash and securities in the event of a brokerage firm’s bankruptcy, other financial difficulties, or if customers’ assets are missing. SIPC insurance does not apply to precious metals or other commodities.

REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited diversification and sensitivity to economic factors such as interest rate changes and market recessions.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

The returns on a portfolio consisting primarily of environmental, social, and governance-aware investments (ESG) may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. The companies identified and investment examples are for illustrative purposes only and should not be deemed a recommendation to purchase, hold or sell any securities or investment products. They are intended to demonstrate the approaches taken by managers who focus on ESG criteria in their investment strategy. There can be no guarantee that a client's account will be managed as described herein.

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

Any type of continuous or periodic investment plan does not assure a profit and does not protect against loss in declining markets. Since such a plan involves continuous investment in securities regardless of fluctuating price levels of such securities, the investor should consider his financial ability to continue his purchases through periods of low price levels.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.

The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes. Morgan Stanley Wealth Management retains the right to change representative indices at any time.

Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance

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