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Rx: Canned goods and ammunition

But real assets will help provide diversification, inflation protection and a wager on growth

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By Brad McMillan

March 31, 2008 6:01 am ET

As I write this on a New England winter day, the television is on. In the best television tradition, the weather woman is predicting a blizzard.

But these days, a blizzard isn't just a blizzard, it's a catastrophe followed by the advance of the glaciers, the collapse of civilization and mass cannibalism.

It's the same with economic news. Remember 2000-2001? That's when the U.S. economy collapsed, leaving crowds of starving programmers and a desert wasteland where Silicon Valley used to be.

What about the real estate collapse of the early 1990s? To listen to the doom-sayers, real estate has been a dead asset class since then, with no market activity — either commercial or residential — and only the howling ghosts of dead brokers to stir the dust in the empty streets.

Anyone who has made it this far must realize that I'm not (entirely) serious. But as an investment expert, I can be clear in recommending where my clients should be today in anticipation of the next coming collapse: real assets.

Without going overboard — in which case I would recommend canned goods and ammunition as my top investment choices in 2008 — I think there is a place for real assets in your clients' portfolios.

In an inflationary environment, or more difficult times, financial assets can become worthless pieces of paper. Even if financial assets continue to do well and economic Armageddon isn't around the corner, the appeal of real assets remains.

When financial assets disappear, real assets still have real value. You can eat food and live in a house.

Growing populations, rising standards of living and a finite planet argue for resource prices to rise.

Chinese demand for meat, which requires the input of much more vegetable matter than the equivalent calorie value in noodles, almost requires wheat prices to increase — and they are increasing. Whether peak oil is with us now or in 20 years, the oil supply is finite and demand continues to grow. Water, the ultimate in inelastic demand goods, is also finite — and getting scarcer.

Closer to home, real assets also provide a foundation of value. Despite short-term problems and a deflating bubble in many areas, people still have to live, work and shop somewhere. Real estate has intrinsic value, unlike a stock or a bond. People have to eat; farmland has an economic value. Wood will continue to be needed; timber has positive value.

Another benefit of real assets is that they provide some degree of inflation hedge. Think about it. Real assets are things. Inflation means things cost more. This means that these assets will act differently from the financial assets that make up most portfolios, thus providing diversification.

Need proof? The two major commodities indexes are essentially uncorrelated with the Standard & Poor's 500 stock index and are positively correlated with the consumer price index.

Another way to think about it is from an event risk perspective. Event risk is usually bad for stocks and good for commodities, as events typically disrupt business prospects, reducing the values of stocks, but also reducing the amount of commodities available, increasing their value.

There are a number of ways the average investor can get exposure to real assets:

• Exchange traded funds and mutual funds in specific asset classes such as timber or, more generally, in natural resources.

• Structured notes linked to commodities indexes.

• Managed futures accounts.

• Specific stock exposures.

• For the larger or institutional investor, private offerings and direct investments.

The products are available now, driven by increasing interest and demand. When you are examining a product, though, be sure that the effects are what you expect.

Several products I have examined, especially on the ETF side, have shown more exposure to stock market performance than to the intended underlying assets.

What if the worst does come? In that case, you might want to consider adding canned goods and ammunition to your clients' portfolios.

But if we somehow survive, real assets can still provide diversification, inflation protection and maybe even a positive return.

Brad McMillan is the director of alternative investments at Commonwealth Financial Network® in Waltham, Mass. He can be reached at bmcmillan@commonwealth.com.

For archived columns, go to investmentnews.com/investmentstrategies.

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