Why investing in real assets?

Optimizing the trade-off between performance and risk: this is the key to building an ideal portfolio capable of ensuring maximum returns relative to each investor's risk tolerance.

This concept, widely recognized and shared today, was groundbreaking when it was first theorized in the early 1950s by American economist Harry Markowitz, who was awarded the Nobel Prize for his theory.

According to Markowitz, the foundation of a well-constructed portfolio lies in the concept of diversification, which allows for maximizing returns and, more importantly, minimizing risks associated with a single investment by allocating investments across different assets capable of reacting differently to the same external shocks: on one hand, equities, on the other, bonds, whether corporate or governmental.

Markowitz's rule, largely adopted by the investment industry of the last century, has been summarized into two numbers: 60 and 40. 

According to asset management experts, in order to minimize the risks associated with an investment while simultaneously maximizing the probability of gains, one should split their portfolio, investing 60% of the total in stocks and the remaining 40% in fixed income instruments.

Analyses of market performances between 1929 and 2022 on the US stock index and Bloomberg U.S. Aggregate Bond Index have validated this theory. In nearly a century of analysis, only four times have both the stock and bond indices simultaneously shown negative returns: in 1931, when the United Kingdom abandoned the Gold Standard; in 1941, with the United States entering World War II; in 1969, with American hyperinflation generated by the Vietnam War and in 2022, when central banks across the globe started raising interest rates to fight inflation.

OPPORTUNITIES OFFERED BY ALTERNATIVE INVESTMENTS

However, Markowitz's theory, extraordinary for its time, has undergone significant changes in recent years with the introduction of a third category of investments, commonly referred to as alternative which has led to reshaping the weight of different asset classes within the ideal portfolio: equities and bonds have given way to alternative investments, which should now account for 30% of the portfolio.

The new ideal portfolio has thus transformed into 40% equities, 30% bonds, and 30% alternative investments. 

These alternative investment instruments, compared to traditional products (i.e., stocks and bonds), include private equity, private debt, and direct or indirect exposure to real estate assets, all with a single mission: to adhere to the rule of the three D's: Diversity (low correlation with other portfolio components), Durable (positive returns with low volatility), and Defensive (low redemptions on days of stock market downturn).

ADVANTAGES OF ALTERNATIVE INVESTMENTS OVER A "TRADITIONAL" PORTFOLIO

In fact, beyond the purely economic factor related to higher returns offered by alternative investments compared to traditional ones (as compensation for lower liquidity and greater deregulation), alternative investments offer several advantages related to reducing the overall portfolio risk, optimizing return on invested capital.

Starting with the decorrelation from public markets. An investment in private debt or real estate assets, private equity, or commodities, for example, typically exhibits a trend that is almost entirely detached from that of equity and bond markets, thus safeguarding capital from possible downturns in listed markets.

Moreover, alternative investments (especially gold or infrastructure) also offer better protection against inflation, a factor particularly appreciated by investors in recent years characterized by double-digit price growth, prompting monetary authorities to take action through interest rate leverage. 

Finally, some alternative investments, such as hedge strategies, can be used as hedging instruments to protect the portfolio against specific market risks or investment risks.

RETURNS OFFERED BY A 40/30/30 PORTFOLIO vs. 60/40

But this is not just theory. An analysis conducted in 2023 by KKR [2], the prominent american private equity firm, demonstrated that comparing the average returns provided by a 60/40 portfolio to a 40/30/30 portfolio over the period 1928-2021 shows that the latter offered a higher return during periods of high inflation, with an average annual return of 4.3% compared to 1.5% for the stocks/bonds portfolio.

On average, according to KKR's results, the presence of alternative investments in a portfolio provided an average annual return of 9.6% over the analyzed period compared to the 9.3% offered by the stocks/bonds portfolio.

An experiment similar to that conducted by KKR, was carried out by YELDO research team, who built an alternative portfolio  by allocating 20% of assets to YELDO deals. Even in this case, the results were surprising.

"If in the period 2019-2021 the average correlation between stocks and bonds was 0.23, in the last two years we have seen an almost threefold increase in the correlation level between the two asset classes, putting traditional portfolios in crisis," explains Lorenzo Belloni, Chief Investment Officer at YELDO Group.

"With the increase in correlation between stocks and bonds, the role of alternative investments in adding diversification to investor portfolios is stronger than ever. Integrating a portion of private equity, private debt, or real estate within investment portfolios can stabilize returns and provide resilience, especially in adverse market conditions, as demonstrated by several large institutional investors who have increased their allocations in alternative investments."