Investors looking to achieve environmental and social goals while earning market-rate returns might know to look at financial assets, like stocks and bonds. But fewer have considered investing in real assets like timber, real estate and infrastructure—physical assets, in other words.
The Financial Case for Investing in Real Assets
Investing in areas like affordable housing, green buildings, and sustainable agriculture allows investors to take advantage of expanding opportunities to make a genuine impact on the environment or the social structure of a neighborhood or region. What’s more, according to a paper by the ImPact, a nonprofit network of family enterprises dedicated to making measurable social impact investments, real assets have three key characteristics that make them attractive from the point of view of profit:
- Lower correlation with other assets: Correlation refers to the way some assets move in tandem, such as during a market sell-off. Because real assets have a low correlation with public equities, they may provide some safety to a portfolio in times of economic crisis.
- Protection against inflation: When currencies lose value, physical assets like real estate and timberland actually tend to appreciate. Therefore, real assets can be a good hedge against inflation-caused portfolio depreciation. Also, when owners incorporate sustainable practices into their real assets, for example making a building green, their assets may even increase in value.
- Cash-flow predictability: Although impact investing in real assets is a relatively new trend, there are indications that these assets may provide long-term cash flows similar to other assets in the class.
According to a study by Cambridge Associates and the Global Impact Investing Network, “risk-adjusted market rates of return are achievable in impact investing, as evidenced by the fact that the distribution of impact investing fund returns mirrors the distribution of conventional real asset fund returns.”
To illustrate, the study’s authors cite the performance of funds in the timber sector that were established between 1997 and 2014. The study noted that as of June 30, 2016, these funds have produced a pooled net internal rate of return of 5.9%. This compares favorably to conventional timber funds established between 1997 and 2014, which saw returns of 3.3% over the same period.
For the purpose of the paper, impact funds are defined as having “clear, publicly stated impact objectives.” The authors noted that common impact objectives in the timber sector include commitments to “sustainable timber production, land conservation, and biodiversity conservation.”
Meeting Needs and Achieving Goals
Perhaps most importantly, investing in real assets enables investors to closely align their environmental and social values with their portfolios. For example, sustainable timber harvesting can be self-replenishing. Likewise, investments in sustainable farming produce higher and healthier yielding crops and livestock.
Also consider the urgent need for affordable housing. This need is likely to compound as urban population growth is predicted to increase by as much as 2.5 billion people worldwide by 2050. Housing also has a massive impact on the environment. Buildings account for approximately 40% of energy use worldwide and that same percentage of carbon dioxide emissions in the United States. That given, the potential impact of investing in real assets like green buildings and affordable housing starts to become clear.
Governments often provide tax credits, such as the US Low Income Housing Tax Credit, that make such investments even more attractive—not that they aren’t already. Green buildings themselves are a $260 billion market, expected to grow by 13% a year through 2020, according to ImPact. This trend is driving the creation of sustainable real estate investment trusts that can help families improve their impact.
Furthermore, investing in sustainable infrastructure such as energy, public transport, water supply, and sanitation can yield beneficial results. It’s an excellent opportunity to make an environmental and social impact while maintaining healthy returns. According to the Global Commission on the Economy and Climate Change, the requirements for infrastructure investment are about $6 trillion a year.
As the ImPact study said: “Impact investments in real assets have the potential to improve the availability and longevity of natural resource systems as well as help ensure a basic, affordable living standard for those in our communities and around the world who are underserved.” Real assets are the bedrock of a healthy society. For that reason, it may make sense to consider them when building an impact portfolio.