Many investors are interested in using real asset classes like commodities, real estate and natural resources to diversify their investment portfolios. The reason is that real assets offer different risk and return characteristics than the traditional asset classes of stocks, bonds and cash.
They also may provide several advantages, including:
While some investors choose to target a specific area of the real asset investment landscape, others may prefer broad exposure to the entire range of real asset classes. The emergence of exchange-traded funds (ETFs) has enabled individual investors to invest in real assets on a class-by-class basis in a cost efficient manner. We believe, however, choosing the right mix of investments to maximize the potential advantages of broad real assets strategy may be complicated, resulting in sub-optimal portfolios. Our opinion is that the wrong mix of real assets may lead to inadvertently increasing a portfolio’s overall volatility. Our research finds that a professionally managed, optimally balanced real assets fund may offer an easier way to capture the benefits of these investments.
THE FLEXSHARES SOLUTION: A TURNKEY REAL ASSET FUND
The FlexShares Real Assets Allocation Index Fund (ASET) is an ETF that seeks to provide broad, diversified exposure to real assets by tracking a custom index, the Northern Trust Real Assets Allocation Index.1 Northern Trust Investments Inc. (NTI) is the investment adviser for FlexShares ETFs.
The underlying index is composed of three FlexShares ETFs:
NTI uses a methodology based on modern portfolio theory2 to optimize the three underlying funds. This methodology involves analysis of the volatility of the underlying securities held by the three ETFs to determine the optimal proportion of each fund in the final portfolio, with an eye toward minimizing volatility and reducing risk.
Finally, NTI rebalances the weightings of each ETF in the index annually. It also applies constraints to help ensure that exposure to each fund is no lower than 10% and no higher than 50%.
REAL ASSET DIVERSIFICATION, PROFESSIONALLY OPTIMIZED
We believe that the ETFs used to create the Northern Trust Real Assets Allocation Index offer efficient exposure to the potential benefits of real asset investing. For example:
Furthermore, it is our view that NTI’s index methodology offers an optimized weighting of these real asset classes based on the expertise of experienced investment managers. This approach aims to capture the advantages of real asset investing in a balanced way, while minimizing volatility, in a streamlined core real asset holding.
Adding real assets to a portfolio may provide inflation hedging protection, income potential and capital appreciation. But it can be difficult for individual investors to build an optimally diversified real asset portfolio to achieve these goals while also minimizing volatility.
The FlexShares Real Assets Allocation Index Fund (ASET) seeks to offer a turnkey core real asset holding that captures these advantages while minimizing volatility and risk. Its portfolio comprises three separate FlexShares real assets ETFs, each designed to optimize exposure to specific areas of the real asset investment landscape, assembled according to a methodology that seeks to minimize volatility without constraining return.
1 The Northern Trust Real Assets Allocation Index is designed to provide a core real asset allocation that addresses inflation hedging, diversification and income needs with a focus on reducing volatility.
2 Modern portfolio theory (MPT) is a theory on how risk-averse investors can construct portfolios to maximize expected return based on a given level of market risk. Harry Markowitz pioneered this theory in his paper “Portfolio Selection,” which was published in the Journal of Finance in 1952.