Asset correlation, or the degree to which asset prices move in tandem, results from a common sensitivity to underlying economic forces such as growth, employment or inflation. Real assets, in particular, share a common sensitivity to inflation. This sensitivity is embodied through a positive correlation to inflation and as a result, partially hedges real asset investment values against a force that ordinarily decreases the value of most investments.
Real assets capitalize unexpected inflation in their returns. As a result, real asset returns display a positive correlation to inflation. This positive correlation to inflation creates a unique return pattern that displays a low correlation to other asset classes - therefore holds a potential diversification benefit to portfolios of traditional assets.
Real asset investment exposure can be implemented using a basket approach or portfolio optimization approach. Several real assets however, involve private market instruments where liquidity can be an obstacle to strategic reallocation. From this standpoint, an allocation to real assets must come with the acceptance of a sub-optimal exposure at the benefit of reaching a higher efficient frontier than with a portfolio of U.S. Stocks, Developed ex-U.S. Stocks, and Core U.S. Bonds with real estate as the sole inflation hedge.