Real assets play a variety of roles in a portfolio, including driving growth, generating income, providing diversification, and preserving wealth. Sizing of real assets holdings and the composition of a real assets portfolio should be driven by both investor needs and the intended role of these assets in the portfolio. Generally speaking, portfolios holding real assets for growth should incorporate higher return/higher risk investments, including private equity energy & mining and opportunistic private equity real estate, as well as attractively priced, higher-volatility, liquid strategies such as natural resources equities (NREs), energy credit, and master limited partnerships (MLPs). Investors using real assets as lower volatility, diversifying assets should hold core real estate, infrastructure, royalties, TIPS, and cash.

Real assets deserve a place in portfolios, but not solely for their perceived sensitivity to inflation. While real assets may provide some hedge against inflation, just how much is uncertain—inflation betas are low and unstable, making it hard to predict the protection investors will get in a period of high, unexpected inflation. In particular, investors with more growth-oriented investments are more likely to be disappointed with their “insurance” than investors holding assets like commodities, as growth-oriented real assets are more likely to track broad equity markets than either commodity indexes or inflation.

Given recent price declines across most real asset strategies and increasingly attractive valuations—but also ongoing uncertainties in these markets—today we advise investors to revisit the role real assets play in their portfolios and assess whether the composition of their portfolios is in line with their intended objectives.

Investors holding real assets for growth should consider rebalancing. NREs and MLPs are undervalued today. NREs on an index basis have fallen in part due to weakening oil prices and the strengthening US dollar. With 7%+ yields, MLPs are more appealing than they have been in several years, though they will not necessarily resume their historical pace of distribution growth quickly; investors should proceed with caution. We continue to favor NREs over direct commodities on a valuation basis. NREs offer commodity-like exposure with fewer implementation headwinds than commodity futures markets.

Investors able to tolerate both the volatility of growth-oriented real assets and illiquidity should consider committing to private equity energy. With long-term capital, the flexibility to be more opportunistic, and the ability to operate assets, dedicated private equity energy managers are most able to take advantage of the current dislocation. Managers with a significant amount of “dry powder” will be best positioned, particularly ones without issues in existing portfolios. While we favor established managers that have invested across multiple commodity price cycles, some of the new market entrants focused on lower mid-market assets may also be poised to perform well in this market.

Investors seeking an opportunity in distressed energy should be patient—opportunities are on the horizon. The continued decline in oil prices is putting downward pressure on highly levered public producers, services companies, and unnatural owners to sell non-core assets in order to raise cash and clean up balance sheets. However, credit investments have not yet evolved into a wave of true distressed opportunities. Capital markets have remained open to exploration & production companies, with borrowing reaching $31.4 billion in second quarter 2015, up 11% from first quarter 2015. We expect the environment will change late this year or in early 2016 as energy companies’ hedges roll off, they burn cash, their lenders reset the borrowing bases, and/or they begin to face debt maturities.

We do not recommend adding a dedicated energy credit manager today. Generalist high-yield and credit managers will likely have significant energy exposure and can also pivot to more attractive sectors over time. Managing energy assets requires technical skill and experience that may not coincide with the procedural and administrative strengths of traditional distressed managers. Accordingly, manager selection and monitoring the evolution of partnerships and talent acquisition will be paramount during this cycle.

Meagan Nichols is the Deputy Head of Global Investment Manager Research and the Head of Real Assets Research for Cambridge Associates.

For more on the topics discussed above, please see:
Has Recent Market Action Created Opportunities for Investors?
Value in the Oil Patch, for Investors With a Strong Stomach
Has This Summer’s Sell-Off in Energy-Related MLPs Changed Their Appeal to Investors?
Time to Get Real About Real Assets