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This charticle takes a closer look at real return strategies. It depicts risk levels, product availability and the configuration of
each real asset strategy. The three pie
charts shown here represent examples of
real return structures that are appropriate
for diversified portfolios. The size of the
real asset allocation and the types of
strategies employed will depend on the
unique circumstances of each investor.
The portfolios can be further customized
to achieve more conservative allocations
that are fixed income heavy (e.g., by
adding more TIPS) and for more aggressive, equity-heavy portfolios (e.g., by
adding private investments).
A wide variety of asset classes are used in
real return portfolios displaying a range of
public and private equity and fixed
income-like characteristics. On the reverse
side we offer greater detail on the benefits,
risks, investable universes and benchmarks that accompany each real asset
class.
Multi-asset class real return fund or stand-alone Treasury InflationProtected Securities (TIPS) allocation.
50% TIPS allocation keeps portfolio liquid and less volatile.
Private Energy
TIPS
Expected Return cash
equity
equity
high
excellent
excellent
Liquidity poor
excellent
equity
excellent
equity
high
Commodities
Correlation with CPI low
high
Liquidity poor
excellent
equity
excellent
excellent
excellent
excellent
Liquidity poor
excellent
Liquidity poor
excellent
excellent
excellent
high
high
high
TIPS
Higher Liquidity
Higher Complexity
REITs
REITs
equity
equity
high
high
TIPS
Priv
ate
Ene
rg
Infrastructu y
re
ure
Agricult
nd
Private Real Estate
erla
b
m
i
T
Agriculture
REITs
equity
equity
high
excellent
excellent
Liquidity poor
excellent
excellent
equity
equity
excellent
excellent
Liquidity poor
excellent
excellent
Timberland
Expected Return cash
equity
equity
high
excellent
Liquidity poor
excellent
excellent
excellent
Liquidity poor
excellent
excellent
excellent
Liquidity poor
excellent
excellent
excellent
high
high
equity
high
excellent
excellent
equity
excellent
equity
Comm
oditie
excellent
excellent
TIPS
Natural
Resource
Equities
Infrastructure
Commodities
equity
high
equity
C om
mod
ities
RE
ITs
high
high
high
high
PRODUCT AVAILABILITY
Eight multi-asset real return strategies for DB real return mandates of
$1 million or greater, mostly in mutual fund vehicles. Six of these
strategies are available to DC plans.
Twelve multi-asset real return strategies in commingled or mutual funds
for real return mandates of $5 million or greater.
Exchange-traded funds (ETFs) are available in each asset class to
construct more customized portfolios.
Agriculture
Commodities
Infrastructure
Benefits
Benefits
Benefits
Solid long-term inflation hedge; capital appreciation from income producing
investments.
High current income, low observed volatility. Should outperform stocks and will trump
bonds in periods of rapidly rising or high inflation.
Risks
*"!
$ !
Risks
Investable Universe
$900 million (investable U.S. agriculture), representing 1% of total U.S. agriculture.
Often difficult to find farms of a large enough value for institutional investments. Less
than 20 institutional managers accessed via separate accounts or commingled
funds.
Risks
Highly volatile with a steep downside and should be actively rebalanced with
uncorrelated assets.
Investable Universe
$300 trillion (commodities derivatives market); 50 active and passive institutional
commodities strategies, accessed publicly.
Returns are bond likeimpacted by interest rates and credit market conditions.
Long-term, illiquid investment with thin supply of institutional-quality products. Political
and regulatory risks as well as public controversies over privatization.
Fees based on committed, not invested, capital therefore performance and fee
calculations are usually estimates.
Natural resource equities are the equity securities of commodity producers, generating
returns from two sources: dividend income and capital appreciation. Commodity producers
have an indirect hedge to inflation from exposure to the underlying spot commodities.
Benefits
Risks
Risks
Benefits
More correlated at times with equity markets than direct commodity exposure.
Investable Universe
Large universe through energy sector equities whose earnings are linked to commodity
prices, ETFs and hedge funds (e.g., CTAs, global macro).
REITs
REITs are publicly traded real estate securities that provide liquidity not
found in private real estate. Similar to natural resource equities, returns stem from
dividend income and capital appreciation. Inflation-sensitivity is derived from the
characteristics of the underlying private real estate assets.
Benefits
Provide access to diversified real estate assets not found in other vehicles.
Solid long-term inflation hedge; outperform bonds in periods of rapidly rising or
sustained high inflation.
Liquidity enables REITs to replace private real estate in smaller portfolios. REITs
complement private real estate in larger portfolios with liquidity and exposure to
specific market segments, such as regional malls and CBD offices.
Risks
Sensitive to interest rates and management.
Highly correlated to small and mid cap equities; highly volatile.
Investable Universe
192 institutional-quality global real estate securities, totaling $555 billion; 126
institutional-quality U.S. real estate securities, totaling $359 billion, as well as a limited
number of out-of-benchmark securities.
Benchmarks: FTSE NAREIT Equity Index (domestic institutional-quality);
FTSE EPRA/NAREIT Developed REITs Index (global institutional-quality)
history.
Plan sponsors adding TIPS to their DC fund lineup must be willing to assume the
opportunities for investors looking beyond the more mature U.S. timberland market.
This paper addresses how to offer TIPS in a DC planas part of a core fixed
income fund, within target date funds, as an available option in a self-directed
Investors seeking inflation protection and portfolio diversification are shifting focus to real asset
strategies and due diligence is increasingly trained on investments that represent finite
utilization.
resources. Timberland is a compelling investment strategy due to a variety of unique characteristics, including its biological growth component, income generation potential and diversification
As the market and economy show signs of recovery, plan sponsors are taking a closer
benefits. The majority of institutional investment in timberland has been within the U.S., which
look at their defined contribution plan fund lineup. They are asking questions like: Does
represents the largest share of the global timberland marketplace. However, the investment
it allow for sound diversification? Does it meet the demographic needs of plan partici-
industry has begun to explore opportunities in the vast timberland areas outside of the U.S.
pants? Can it weather the next stormwhatever that might be? In particular, Treasury
In this paper we explore global timberland investments, including the investment manager uni-
Inflation-Protected Securities (TIPS) is an asset class that bears closer scrutiny, both for
verse, opportunity set and the fundamental benefits and risks of looking beyond the U.S. We
describe common challenges in benchmarking and obtaining historical performance, and examine implementation options.
Investable Universe
$1 trillion (global universe) with 120 managers worldwide; U.S. and Europe comprise
40% of the total. MLP markets are small but growing.
Private Energy
Natural Resource Equities
inflation in the future has motivated some plan sponsors to pursue offsetting
opportunity set and attractive pricing. However, investors face country and
environmental risks, scanty return data for benchmarking, implementation
challenges and a limited manager universe with little quantifiable performance
Due to 2008 and 2009 monetary and fiscal stimulation, the possibility of higher
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Benefits
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Solid long-term inflation hedge, with a high level of short-term correlation to inflation.
Core strategies provide high current income, a relatively high rate of return and low
observed volatility. Should outperform stocks, and will certainly trump bonds, in
periods of rapidly rising or high inflation.
Risks
Investable Universe
Illiquid; significant declines in early 1990s and 2009 not related to inflation.
Investable Universe
Benchmarks: Dow Jones Energy Sector Index; S&P 500 Energy Index
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Contact Information
For more information please contact your Callan consultant.
San Francisco
415.974.5060
Atlanta
770.618.2140
Timberland
Timberland displays characteristics of more than one asset class with
attributes of real estate, fixed income and commodities. It derives its revenue
from its biological growth value, land prices and the price of timber. It is difficult to
implement in a DC framework because of the daily valuation requirement.
Benefits
Solid long-term inflation hedge, stemming from biological growth and income
generated by harvesting a commodity.
High current income, low correlation with other assets, a relatively high rate of return
and low observed volatility. Should outperform stocks and will trump bonds in periods
of rapidly rising or high inflation.
Risks
Limited transaction activity and history.
Long-term, illiquid investment with thin supply of institutional-quality products.
Unique operational risks (e.g., fire, pests, water shortage, disease, regulation).
Investable Universe
$300 billion est. (total global timber), with the majority in the U.S. ($212 billion),
representing 1.5 billion hectares. About 25 institutional-quality investment managers
globally accessed via direct separate accounts or closed-end commingled funds.
Benchmark: NCREIF Timberland Index (limited availability of data)
TIPS
Chicago
312.346.3536
TIPS are notes and bonds issued by the U.S. Treasury as inflation-linked
debt. Inflation-indexed bonds are quoted in terms of a real yield. TIPS are
considered the purest hedge against CPI inflation as their principal and interest are
adjusted for actual or realized inflation.
Denver
303.861.1900
New Jersey
973.593.8050
Benefits
Positive risk-free real returnif the embedded real yield is positive at purchase,
positive real return will result at maturity.
Risks
Impacted by supply and demand pricing factors because of limited supply and
issuance. Can produce negative real returns over short periods.
Low yieldsmany investment programs need a higher real return to meet return
assumptions.
Investable Universe
$1.5 trillion (global inflation-linked bond market), of which $500 billion is outstanding
U.S. TIPS. 70 institutional U.S. TIPS strategies accessible to institutional investors and
over 20 global inflation-linked bond strategies.
Privately Traded
About Callan
Founded in 1973, Callan Associates Inc. is one of the largest
independently owned investment consulting firms in the country.
Headquartered in San Francisco, Calif., the firm provides research,
education, decision support and advice to a broad array of
institutional investors.
www.callan.com 2011 Callan Associates Inc.
Published January 2011