Bounce back with real estate investment
In such a scenario, real estate investment trusts (REITs) offer an effective alternative. It can provide an enhanced diversification strategy for investors looking to reallocate portions of their fixed income portfolio in anticipation of a possible rise in interest rates.
A REIT is a company that owns, operates or finances real estate, and it generates rental income and provides an investment opportunity, such as a mutual fund. This allows investors to enjoy valuable real estate and earn income and dividend-based returns. REITs also contribute to capital appreciation.
Go global to develop locally
Globally, most REITs are publicly traded, unlike physical real estate investments. Hence, they are very liquid and invest in a wide range of property types including apartment buildings, cell phone towers, data centers, hotels, medical facilities, offices, shopping malls, warehouses, cold stores, self-storage facilities and residences for the elderly. Therefore, global REITs capture a greater number of diversification themes, better than domestic REITs, which currently largely cover commercial or residential properties. Historically, global REITs have offered the highest long-term returns at 10.4% compared to investment alternatives like private real estate (8.5%), stocks (7.5%) and bonds. (4.5%).
REITs, and in particular global REITs, are a very interesting asset class to add to investor portfolios.
Stay afloat thanks to asset bubbles
REITs are expected to gain in importance as the situation evolves. The Covid-19 lockdowns have seen governments and central banks inject a lot of liquidity to revive demand and prevent economies from sinking, which could eventually lead to the creation of asset bubbles. Therefore, investors need to re-evaluate their asset allocation and realign their investments to changing trends in various asset classes and inflation-interest rate dynamics.
Multi-asset investing is generally viewed as the most resilient way to move forward in such cases. It is about investing in weakly correlated or negatively correlated asset classes so that when one asset class is underperforming, the other compensates with its good performance. This balances the returns of the portfolio. Studies show that 92 percent of investor returns are the result of compelling asset allocation, while only 8 percent of returns are based on stock selection and timing.
DIY strategies of the smart investor
Many investors make their own asset allocation through dynamic asset allocation, switching from debt to stocks and vice versa. Some investors follow a fixed asset allocation like 60:40 in favor of equity or debt, depending on their life cycle stage or age criteria. In both cases, investors refrain from taking interest rate or credit calls on the debt part, because debt is only a temporary and symptomatic solution, which turns into actions over time. as stock valuations become cheaper. At the present time of low interest rates around the world, this allocation to debt generates negligible returns and weighs on the overall performance of investor portfolios.
Profit from the price increase
Global inflationary pressures present a good time for REITs to outperform bonds and stocks. Rising prices lead to higher real estate rents because leases are directly linked to inflation. The current economic situation is prone to rising inflation. This is advantageous for REITs as high inflation rates also reflect higher rental income. REITs can function as a natural hedge against the current inflationary environment. In the past, they have outperformed other asset classes, especially in a scenario of moderate inflation.
Over the past four decades, the REITs Index has outperformed the S&P 500 by 2%, while over the past five years, stocks have outperformed REITs. However, higher inflation would allow REITs to make a comeback. Indian investors can now gain a lot from global REITs in terms of geographic and currency diversification. It adds an attractive and new dimension to an investor’s portfolio.
The post-containment vaccinated economy is expected to make larger returns and serve the REIT asset class more as markets stabilize and expand.
(The author is CEO of PGIM India Mutual Fund. The opinions expressed are personal.)