After getting burned by the Internet, high-tech and a horde of dotcom companies whose business plans turned out to be more fantasy than plan, some investors appear to be looking for investments they can put their hands on.
That's one theory, at least, for why there's been a resurgence in hard-assets investing.
That's right, hard assets. Remember that asset class? It represents the ultimate in tangibility: real estate, precious metals, oil and gas, timber and other commodities. Cyclical and volatile, these investments have long been considered ideal portfolio diversifiers because of their relative low correlation to the stock market.
For many investors, however, it is also an asset class that was all but forgotten through much of the 1990s, when technology was the rage and everyone and his neighbor felt the need to buy into the stock market. Inflation was also benign in that period, muting one of the attractions of hard assets-seen by some as an inflation hedge.
"Hard assets had a very difficult period," says Sandy McIntyre, vice president and senior portfolio manager of Century Select Capital Corp., a hard asset mutual fund company in Toronto. "Money flooded into glamorous areas of the market, and the hard asset areas had no access to capital. So during that cycle, asset performance was generally fairly poor."
Now that the glamour is gone from the stock market, investors are gravitating back to hard assets, with most sectors outperforming the broader market. In the first quarter of 2002, for example, stocks in the precious metals sector rose 40.5%, nonferrous metals went up 29.6% and mining stocks gained 25.5%, according to Dow Jones Newswires.
Real estate continued a recovery that actually began in 1999, with the Commerce Department reporting that February sales of new U.S. homes rose 5.3% from January.
Real estate mutual funds were up 9.88%, and those investing in natural resources climbed 8.82%, year to date as of May 7, according to Lipper Inc. indexes. Lipper's Gold Fund index was up 51.42%.
Through the first quarter, gold, real estate and natural resource funds all experienced net inflows, Lipper says. Real estate funds had an inflow of $1.1 billion in new capital, representing growth of 9%, natural resources had an inflow of $400 million, up 7%, and gold saw $200 million in new money, up 11%.
The investments in natural resources are particularly noteworthy considering the sector is coming off a relatively flat year, says Lipper research analyst Jeff Tjornehoj. "The downturn in the stock market hit everybody, whether you were a mutual fund or an individual stockholder," he says. "I think people are looking about, seeing if they missed something along the way. So it's not surprising hard assets are turning up on more radar screens." Jjornehoj also notes that for investors who are wary of the stock market, "real estate is something they can grab and take hold of."
For the financial advisors who stuck to their guns during the tech boom and included hard assets in their asset allocations, the upswing doesn't come as a surprise. But it certainly comes as a relief. Even the most disciplined asset allocators frankly admitted feeling some pressure from clients who questioned the wisdom of investing in oil at a time when technology was crashing through the roof. Clients rarely question such investments anymore, says Marjorie Fox of Rembert, D'Orazio & Fox in Falls Church, Va.
"They are more on our wavelength because the bear market has had them see the benefits of REITs, bonds, hard assets, etc.," Fox says. "They're much more enamored of diversification."
The logic behind using a mix of asset classes was driven home when the bear market struck in 2000, Fox says. While the S&P 500 finally took a tumble that year, the Oppenheimer Real Asset Fund was up 44.4%, the Goldman Sachs Commodities Index was up 49% and the MLM Index of managed futures was up 16.19%.
Those results, as well as rebounds in real estate and the small-cap market, went a long way in softening the blow in client portfolios, even though the typical hard asset allocation was between 5% and 7.5%, Fox says. "Everything really helped," she says.
Some advisors try to be as far removed from the stock market as possible when it comes to diversifying with hard assets. Tom Orecchio, of Greenbaum and Orecchio Inc. in Old Tappan, N.J., says his firm uses vehicles such as oil and gas royalties programs, direct investments in real estate and commodities in the form of limited liability corporations.
By using investment vehicles that do not trade like stocks, Orecchio says, the firm feels it is achieving a greater negative correlation with the stock market. "The essential theory is that a hard asset is anything that removes the equity risk and is non-correlated with the stock or bond market," he says.
He notes that even though mutual funds such as Vanguard Energy or Oppenheimer Real Asset are hard asset allocations, they trade like stocks and carry some equity risk.
"I'd rather buy that same product without having it trade on the stock market," Orecchio says.
The investments are often illiquid and riskier than equities, but "we're looking for diversification to reduce the [total portfolio] risk, not the risk of any single investment on its own."
Many advisors continued to advocate the inclusion of hard assets even in the high-flying 1990s. It's just that it was hard to hear them through all the clatter of the tech boom.
Ibbotson Research, for example, released a report in 1999 that concluded hard assets were a superior portfolio diversifier when compared with bonds. The report, noting that stocks and bonds have been growing more and more correlated over the years, claimed that a 10% hard-asset allocation was suitable for even moderate-risk investors, and that a 25% allocation was warranted for aggressive investors. "The correlation is extremely low, and that's an important factor in building a portfolio," says Ibbotson research consultant Barry Feldman.
On a quarterly basis from 1972 to 2001, commodities had a -0.28 correlation with the S&P 500, compared to -0.19 for long-term treasury bonds, he notes. Advisors point to this lack of correlation as the primary reason for adding hard assets to the typical portfolio-to balance out performance over the long-term. Taken by themselves, advisors note, commodities are highly cyclical and volatile-a trait that sometimes can be a major turnoff to clients.
Quantifying the volatility, Feldman notes that commodities had a standard deviation of 5.4% between 1994 and 2001, compared with 4.5% for the S&P 500. And when comparing the Goldman Sachs Commodities Index with the S&P 500 during the past eight years, commodities had an average monthly return of 50 basis points, compared with 120 for the S&P, he says.
Numbers like these are why many advisors continue to steer clear of hard assets, says Sam Miceli of Miceli Financial Planning in Littleton, Colo. "A lot of them won't touch the stuff," he says. "They look and say, 'Gosh, look at the poor returns and volatility. How can that possibly help your client?'"
Except when Miceli sits down and does the math, a 5% to 7.5% allocation of hard assets goes a long way in reducing overall portfolio volatility. "You play this game long enough, and it boosts your return because it's reducing the risk of the entire portfolio," he says.
Fox points to a comparison of the monthly returns of the MLM Index and the S&P 500 from 1980 to 2001. It shows that both indexes moved in opposite directions 50% of the time and both moved up 43% of the time.
But maybe the most noteworthy characteristic is that they have both moved down in the same month only 7% of the time, Fox explains. "It makes for a bit of a smoother ride," she says.
When it comes to the resurgence in hard-asset investing, other factors are at play in addition to a backlash to the dotcom bubble, says McIntyre of Century Select Capital.
One is the cyclical nature of the asset class. Gold, for example, is rebounding after enduring a bear market for the past five to six years, he says. The real estate sector was bearish for a good eight years before it started to bounce back in 1999. In the precious metals sector, consumption is well in excess of mine supply, McIntyre says, and oil and gas are coming off a three-year down cycle.
But at a time when investors are still getting over the shock of the bubble market and the collapse of Enron, hard assets provide something else, McIntyre says. They're real.
"There is an investor interest in real and discernable cash flows," he says. "The requirement in a hard-asset investment is to essentially convert an asset into a saleable product, and the accounting treatment is relatively transparent. The duration of the asset is understood, and the volatility of the pricing is understood."
McIntyre sees this is as a refreshing aspect of hard assets after the ambiguities of the 1990s' stock market. "Companies should be able to generate cash to reinvest in their business or pay out as dividends to shareholders. Somehow that vision was lost in the 90s. Today, I think people are saying the new paradigm didn't exist."