Why We're Buying Real Assets Instead Of Stocks And Bonds

Summary

• The S&P 500 and 10-year Treasury note are yielding a paltry 1.5%, making them poor choices right now for income investors.
• Even worse: Valuations remain near all-time highs in the stock market, with the S&P 500 at a P/E of 40, meaning there is little margin of safety.
• We believe real assets offer higher yields, higher return potential, and can serve as a much-needed inflation hedge.
• Looking for a portfolio of ideas like this one? Members of High Yield Investor get exclusive access to our model portfolio. Learn More »

Photo by Rafe Swan/Cultura via Getty Images

An asset is any economic resource that has the potential to provide future value. Assets are a tool for building and converting wealth and purchasing power. In the financial world, the most popular assets are stocks, or equities, and bonds. These are known as “financial assets.”

Many investors’ portfolios are exclusively composed of these financial assets.

However, there is another asset class out there, known as “real assets.” A real asset is a physical asset, and its value is intrinsically backed by its substance and physical properties. Examples range from oil, to industrial metals, to raw land and commercial real estate.

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Financial assets have enjoyed a very long bull market, but we think that the tide will soon turn as institutions and retail investors wake up to the big return potential that real assets hold.

Stocks and Bonds vs. Real Assets

For many, stocks and bonds are extraordinarily attractive because of their liquidity and ease of exchange. Many brokers now even offer partial shares and commission-free trading, allowing investors to start a position with as little as a few dollars.

These are all amazing developments, but they’re also partially responsible for the current valuation of these financial assets, which continues to look less and less attractive from a risk-reward perspective.

Consider, for example, today’s yield on the 10-year Treasury. Right now it’s yielding just above 1.7%. This used to be a nice investing vehicle for income-minded, risk-averse investors, but its valuation has grown so high that now it’s not even yielding enough to keep up with inflation and taxes:

Data by YCharts

Corporate bonds are yielding about 3.3%, but are significantly riskier than the 10-year Treasury. By investing in corporate debt, you're taking on a degree of credit risk, and you have to ask whether such little yield and capital appreciation potential are worth that risk:

Data by YCharts

Given their anemic yields and shaky near-term prospects, bonds are not an attractive asset at the moment.

So are stocks any better?

Because of the points we just raised against bonds, many individual investors have left the bond market and turned to stocks. This rotation from the bond market into the stock market is one reason we see such high stock valuations right now.

Have a look for yourself: Currently the S&P 500 (SPY) trades at a PE Ratio of 40, over twice its average valuation for the past 100-plus years.

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Looking at the chart above, we can see that when the S&P 500 (SPY) reaches these high levels, it’s only a matter of time before it dips significantly and reverts to mean. Therefore, investments made at these levels are significantly riskier than they would be at a lower valuation. For this reason, we don’t find the overall stock market much more attractive than the bond market currently.

The Solution? Real Assets

Since valuations are so high in the stock and bond market, we believe real assets offer a much more attractive return potential. They also have a couple other unique benefits.

• Consistent Income: The S&P 500 and 10-year Treasury are both yielding about 1.5%. This is a very poor yield for someone seeking income from their investments. Many real asset investments yield upwards of 5%.

• Higher Return Potential: Not only do they offer generous yields, but since real assets aren’t priced at historically highs like stocks, they also offer more long term return potential with a better margin of safety.

• A Little-Known Inflation Hedge: Real assets are an excellent inflation hedge, because as inflation rises, the value of real estate, commodities, and other real assets tends to increase in price correspondingly.

So given all these positives, why aren’t more investors buying real assets?

We mentioned earlier that many investors favor financial assets like stocks and bonds because they’re highly liquid and it takes little capital to start investing in them. In contrast, if you wanted to own diversified real assets, you would likely need millions of dollars just to get started, and then there’s the issue of managing all of it.

But fear not, there are still ways for the average investor to get exposure to real assets:

How to Invest In Real Assets

What if you could get the best of both worlds and combine all the pros of real assets with the ease and convenience of financial assets? You could essentially buy real assets “wrapped up” in the form of a financial asset.

This is exactly what we teach at High Yield Investor. Rather than having to buy and manage a real asset yourself, you can buy shares in REITs (VNQ) and other real asset-backed companies like Yield Cos and MLPs (AMLP).

Investing in real asset companies has some great advantages:

• Easy Diversification: Many of these companies, like W. P. Carey (WPC) for example, own hundreds of properties all over the world, allowing you an easy way to diversify.

• Income That’s Actually Passive: Every landlord knows the headaches that come with owning physical property yourself. But if you buy REITs/MLPs/etc., you get part ownership of these incredible assets without any maintenance or tenant problems that you’d have to deal with as a manager.

• As Liquid As Financial Assets: If you buy shares of real asset-backed companies, you get exposure to real assets while still maintaining the liquidity of financial assets like stocks and bonds, allowing you to buy and sell easily.

Investing in real assets has never been easier. It’s also one of the best times to get started, as the valuations remain much more attractive than the greater stock and bond market. REITs in particular offer a lot of potential. For the past two decades leading up to the COVID crisis, they achieved an average yearly return of 15%:

Despite these high historical returns, many REITs are now at dirt cheap valuations because of the market’s reaction to the pandemic.

You Can Still Be Ahead of The Pack

Currently, real assets make up about 25% of an investor’s overall portfolio. This number might seem high - until you learn that in less than 10 years, many experts expect real assets could occupy up to 60% of institutional investor’s portfolios:

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Since the stock and bond market offer such paltry yields, institutions are turning to real assets as a source of reliable income.

Given that current institutional allocation is nowhere near 60%, and many real asset-backed companies are still at historically low valuations, we’re continuing to buy real assets ahead of the institutional surge. We recommend you get your hands on some real assets while you’re still ahead of the pack.

Analyst’s Disclosure: I am/we are long WPC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.