The team at UK-based Sourced Capital, the home of property-backed peer to peer investing, notes that diversifying assets in an investment portfolio to address and mitigate the effects of market volatility is a widely-adopted practice.
If you are looking to hedge against volatility in equity markets, then property may be a good alternative, Sourced Capital writes in a blog post.
The stock market provides several key advantages, such as high liquidity and convenient access, which you can’t usually find in real estate or property. However, it’s a property market that provides important benefits such as lower volatility levels than the stock market and “less correlation with public market investment performance,” Sourced Capital explains.
The company adds that because of these differences, real estate investments can be considered complementary to investment portfolios “allocated largely to stocks or bonds, as they provide meaningful diversification.”
Sourced Capital adds:
“Volatility and correlation are the key measurements which illustrate the advantages and disadvantages of each market type. Correlation shows the degree to which investment performances are related to one another. Investments can have positive, negative or no correlation with each other. You should remember that your portfolio is more diversified if you hold investments with little or no correlation.”
Sourced Capital also mentions that volatility is a way to assess or calculate risk over time. When volatility is “appropriately spread,” an investment portfolio generally “a lower risk of loss in the event of poor performance from a given company, sector, market etc,” the company noted.
Sourced Capital pointed out that volatility and correlation can be found in just about every investment, however, their amounts can vary by different features such as the type of investment and the market.
Source Capital further explained that markets can be classified in many different ways, however, the “most fundamental distinction is between private and public markets, where the main differences are the buying/selling dynamics.”
As noted by the firm, the key characteristics or attributes of the public market are as follows:
- high efficiency, “thanks to prices set by the market”
- transparency of transaction details (public information about an investment)
- low transaction costs (low costs of the transaction), which “facilitate high-volume trading”
Sourced Capital also noted that because of these attributes, investments may be sold and bought quickly, “so the public market offers high liquidity.”
The company added that these attributes bring higher volatility as well. Especially efficiency, which “enables high trade volume,” and when the volatility is “combined with a correlation of investment, the stabilization and diversification of a portfolio are diminished.”
Sourced Capital further noted:
“Investors may not even realize how correlated their stocks are. Sometimes, companies from totally different industries share the same risk because of relying on the same fundamental inputs as oil. An increase in oil prices may cause a loss of profit in furniture and grocery companies because of increased transportation costs. And if you own investments in both, the negative risk is doubled in this scenario. So, despite the upsides of the public market, a portfolio composed of public traded investments only is possibly more correlated than you may realize.”
Sourced Capital also mentioned that stocks are typically quite volatile during highly inflationary periods. At the beginning of May 2021, increase in inflation rates have “caused a drop in European stocks prices and Wall Street’s main indexes, led by tech-related stocks,” the company explained.
Sourced Capital also noted that the private market “operates differently than the public market, and thanks to this, they have the power to make a complementary, diversified portfolio.”
The key characteristics of the private market are as follows:
- higher transaction costs
- fewer buyers and sellers than on the public market
- information not public, not shared across parties
- prices are negotiated
Due to these attributes, it can “seem unprofitable at first glance, but the private market has less correlation and volatility than the stock market,” Sourced Capital explained while adding that it also “allows investors to earn above-market returns in a way that is impossible in an efficient market.”
The company added:
“Private market investments are traded at a lower frequency, which results in fewer changes to their real values. Daily changes are generally minor and less frequent than in the public market, meaning investors in property don’t tend to check on their investments on a daily basis. Private market property has a lower trade volume, so it is less liquid than stocks, but it helps to prevent volatility in the values.”
Sourced Capital further explained that property is a “unique hard asset” as well. It can generate income while hedging inflation since they’re “naturally limited.” At the same time, “a rise in inflation would possibly cause a rise in the prices of many asset classes,” the company noted in its blog post.
Sourced Capital pointed out that in the private markets, buyers and sellers are able to negotiate the prices of an asset, so investors are able to get “above-market returns.” This is possible due to the limited number of sellers and buyers, the company explained.
While commenting on why we should you care about low correlation and volatility, the company noted that investments with low correlation can help us lower the risk of an investment portfolio.
Sourced Capital explained:
“If you have uncorrelated assets in your portfolio you don’t have to worry if one of them unperformed, because the strong performance of the other will mitigate the risk. If you want to diversify beyond an all-stock growth allocation, investing in property could help with that balance. Some people don’t want to do this, as individual investment property requires both lots of capital and hands-on participation.”
These days, we have the option of investing in property without actually owning it. This can be done by investing with peer to peer platforms, such as Sourced Capital. It’s “a good way of diversifying a portfolio and decreasing investment volatility,” the company claims while adding that what’s more, “your funds are much more liquid while you are investing in P2P than when you’re holding a property.”
To learn more, check here.