Achieving a productive balance between risk and return is the key to optimal allocation. This applies to both the average investor and the High Net Worth Investor. Accredited investors benefit from a wider suite of available investment options in the alternative space. This wider net of options plays a key role in meeting the criteria of proper asset allocation. But before you jump into the details of percentages, it’s important to familiarize yourself with some of the key concepts of optimal asset allocation. Remember to speak to your personal tax advisor, money manager, and attorney, as needed.
First Things First: What is Your Investment Objective?
Are you looking to preserve capital? Are you after aggressive long-term compounding? Are you seeking to generate consistent income from your capital to finance your lifestyle? These are the questions you must ask yourself prior to developing your asset allocation strategy.
The variety of options within the Private Real Estate space can be tailored to fit your investment objectives. There are more aggressive strategies (such as “Opportunistic”) that align well with an aggressive investment objective. A more conservative objective would fit in well with the “Core” strategy.
These strategies can also be combined within the real estate allocation of your portfolio. This allows for more “fine turning” in order to achieve optimal asset allocation.
What’s Your Investment Horizon?
Asset allocation should be tailored to your investment horizon. If you are an older investor looking to generate cash flow from your portfolio, more conservative strategies may be beneficial. If you’re younger, and have a longer timeframe to work with, aggressive but low volatility strategies may help you meet an aggressive compounding objective.
Investment horizon is tied into liquidity – how quickly do you need access to your money? Real estate is an illiquid investment, and may not be ideal if you anticipate needing speedy access to funds invested.
While there is a trade-off between liquidity and potential returns, it’s important to consider all aspects of your portfolio, focusing on other factors (volatility, liquidity) beyond potential returns.
Target Low Volatility and Consistent Returns for Long-Term Compounding
The foundation of a strong asset allocation strategy is to target assets historically demonstrating both low volatility and consistent returns. Consistent, low volatility returns have historically been found in assets such as Private Real Estate:
*The S&P 500 is the leading indicator of US Large Cap Equities. **The IYR ETF seeks to track the investment results of the Dow Jones US Real Estate Index, which measures the performance of the publicly traded real estate sector of the US equity market. ***NCREIF Property Index is a quarterly measure of the unleveraged composite total return for private commercial real estate properties held for investment purposes only.
Target Assets with A Low Correlation to the Public Markets
Boilerplate diversification advice will suggest putting money into several public market asset classes (Large Cap Equities, Bonds, REITs, International Equities). However, this flawed strategy is not truly diversified because it would be highly correlated to a correction in the public markets.
While REITs may be invested in assets considered to be “alternative”, they differ from Private Real Estate in their high correlation with other public market indices.
An investment in Private Real Estate, with a low market correlation, can further enhance the diversification of your portfolio by giving it the potential to generate positive returns even if the public markets are in a downturn.
Diversification – Even Within Asset Classes
Another flawed diversification strategy is investing in multiple asset classes but failing to properly diversify within the asset class. Even when investing in alternatives such as Private Real Estate, you should pay attention to diversifying within Private Real Estate.
This diversification goes beyond simply investing in several properties. Geographical diversification (multiple metro areas), asset type diversification (office, retail, multifamily, industrial) even property class allocation (Class A, B, C) is necessary to construct a diversified real estate portfolio.
At MLG Capital, our funds typically invest in 20-25 properties, diverse in property type, geographic location, and property class. This diversification is a key factor in hitting targeted returns and delivering value to our investors.
A team of investment professionals (financial advisors, CPAs) can provide additional advice and insight into constructing a portfolio meeting both your investment objectives and the circumstances of your tax situation. There are a myriad of factors involved in constructing a High Net Worth Investor’s portfolio. The concepts detailed above provide an ideal starting point to determine what best meets your needs.