Just as a solid foundation helps a skyscraper stand strong in all conditions, a diversified portfolio helps your assets withstand disruptions. Different types of assets in different markets will not be affected by the same set of risks.
Not all diversification strategies are created equal. Diversifying effectively means looking outside the public markets and traditional securities investments, just like Fortune 1000 pension funds do.
Before the next crash
Buying stocks across a lot of industries or indexes might give the illusion of diversification, but this strategy likely won’t protect your assets in a down market. Public markets are highly correlated—when stocks go down, they all go down together. And typically, when the market crashes, there is a ripple effect and markets crash all over the world.
The way to build a truly diversified portfolio is to take advantage of private markets, which are less correlated. Private markets operate differently, so they are less sensitive to movements in public markets.
Ideally, your private investments will perform well, providing long-term returns and, if possible, regular income. Private real estate investments in particular have low correlation with the stock market and have the potential for long-term appreciation and regular income payments.
To understand why, let’s examine two major features of public markets: efficiency and liquidity.
You can’t beat efficiency
Publicly traded companies have to disclose their financial information to the entire world. With millions of investors and institutions focusing on a limited number of publicly-traded companies, there are a lot of minds analyzing a relatively small amount of information.
Because of this, public markets are efficient—the price of any given asset reflects all available relevant information. There’s nothing an individual investor can know about a publicly-traded company that can’t be known by all other market participants.
You can’t outrun liquidity
Publicly-traded securities are liquid—they can be traded away in an instant. This flexibility is priced in. Every market participant pays for access to daily liquidity in the public markets, whether or not they realize it. Because the public markets offer the ability to sell an investment at any time, this warrants a lower return for the same asset via a “liquidity premium.” This premium is essentially a charge for the option to liquidate whenever the investor desires.
Large market participants use liquidity to their advantage by automating their trading. Computers can take advantage of any shift in asset prices, conducting massive trades in less time than it takes a human to read an update.
You can still beat the market
No investor can consistently beat a market in which all information is public—transactions happen instantly, and computers take advantage of trends faster than humans can. However, none of that is true for private markets.
Private companies do not have to disclose all of their information to the public. When a private offering is open to the public under Reg CF/A/D, a select amount of information is made available in regulatory filings, platforms, and deal pages.
There are many more private offerings than there are publicly-traded companies. Over 99% of all businesses in the United States are privately owned, with the number of publicly-traded companies shrinking over time. No information clearinghouse or analytics agency can keep up with the opportunities on the market.
This inefficient market offers a lot of opportunities to investors willing to put in the research or take advantage of vetted deals on a platform like Republic. Information imbalances provide opportunities to get in on off-market deals, offer more room for negotiation, and allow investors to invest at more attractive valuations.
In addition to the benefits of market inefficiency, private investments such as real estate, aren’t liquid. Sales take time to set up; buyers don’t appear instantly. Just like the liquidity of public securities, this is priced in. That’s the flip side of the liquidity premium: a potentially more valuable asset for less money, simply because you’re willing to hold on to it longer—otherwise known as the illiquidity premium.
Real estate is… real
Earlier, we mentioned market correlation, or the tendency of asset prices to move together. While market inefficiency and illiquidity make privately-traded assets less correlated than publicly-traded assets, real estate has additional qualities that insulate it from public market trends.
Real estate is affected by differences in regional economies, as well as the fundamentals of the specific asset. Properties in economic centers or popular tourist destinations may perform well regardless of overall economic conditions.
Real estate is tangible. It’s a real, physical asset. A stock market crash or an industry disruption may wipe out equity entirely, rendering some of your stock holdings worthless forever. Under the same circumstances, a piece of rental real estate might pay out less until the economy recovers, but it will continue to exist as an asset.
A note about REITs
Not all real estate investments are private. Publicly-traded Real Estate Investment Trusts (or REITs) are offered on many exchanges. However, they are more highly correlated with the stock market than private real estate funds. They also offer comparably lower returns.
One of the major advantages of real estate is that it can both appreciate in value and pay out a regular income. Having a good idea of your risk tolerance and investment horizon will help you find a balance between risk, income, and appreciation.
For example, a debt-funded commercial property will depend on business tenants to service its debt and payout to investors. These types of properties can yield more during good years but are more vulnerable to recessions and industry disruptions.
A rental property bought outright is likely a much safer investment, but the income may be lower. However, its appreciation in a hot residential market may make for an attractive exit a few years down the line.
Private investing in real estate is a sound diversification strategy, but it can be challenging for individual investors. It’s hard to get good information on property outside your region. The investment minimums can be high—not everyone can afford to buy a property outright or fund development.
Republic helps overcome this barrier by offering vetted deals with low minimums. Our real estate platform allows you to build a global real estate portfolio that reflects your goals and risk tolerance. Check out our real estate deals to start investing today!
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.