Investment in Physical Property has been a cornerstone for multi-asset solutions. However, investing in Physical Property through investments funds, which provide daily liquidity can cause liquidity mismatches.
While the impact of this liquidity mismatch is not observable under normal market conditions, periodically, when these inherently illiquid investments are subject to large amounts of redemption, the impact manifests itself in valuations as well as the ability to monetise the value in the holdings. Thus, when a financial planner advises a client to set aside money to spend in the future, the client is clearly expecting that when the time comes, they will be able to spend it. No financial planner needs to be told the client reaction to, ‘I am sorry, but you cannot have your money’.
With this in mind, we looked to reduce the liquidity impact of Physical Property in our investment portfolios.
We recognize that Physical Property provides diversification to a multi-asset portfolio, but we feel that the diversification provided is due to the inherent nature of the investment, primarily the lack of valid mark-to-market valuations, which characterize a freely traded instrument like a stock or bond, wherein the risk arising out of liquidity are built, into the price.
As we recognize that yields from Property investments (as well as infrastructure and other long-term investments) can be quite high, we felt to reduce the impact of liquidity in the solutions through a daily priced mechanism would be more suitable in the long run. With this in mind, we feel that access to the high longevity assets through Investment Trusts would be more suitable.
The use of REITS in multi-asset solutions allow us to access the cash flows of illiquid assets without subjecting the portfolio to any of the liquidity risk of the underlying assets. It has been a much favoured way of investing in Property across the globe.
In our experience, more and more asset managers, who provide multi-asset solutions and do not have access to in-house property funds, are resorting to the use of REITs as a means to access Property investments. However, REITS tend to be much more correlated with equities rather than the underlying Property holdings. This is because these investments are quoted on an exchange and allow an investor to easily rotate out of this asset allocation as and when he or she chooses. During periods of market instability, REITs tend to exhibit volatility characteristics and correlations akin to equities. However, we feel that it is a small price to pay for the liquidity and ease of investment operability that it brings.
At Dynamic Planner, when considering the asset allocation changes, we felt that using a mix of REITs and Physical Property was an appropriate way to invest in the Property asset class. To cater for the increased volatility and correlation that the mix provided, we decided to cut down our holdings in the Property bucket from 8% to 5%. This, we felt, was the best way to balance the reduced risk from liquidity against the increased risk of correlation in the portfolio.
Find out more about Dynamic Planner’s asset allocation and Asset and Risk Modelling.