In the last CH Minute, we looked at how CH Financial protects its investments on the downside, which can be read here. One of the most important tools we use is diversification within a client’s portfolio, and to achieve true diversification we use multiple asset classes, including both Real Estate Income Trusts (REITs) and Alternative Strategies. In this edition, we focus on why CH uses these two asset classes.
What are asset classes?
Asset classes, or asset class categories, in their simplest form, are groupings of comparable financial instruments. For example, when a client buys a mutual fund that invests in large global companies, they are investing this portion of their wealth in a large-cap (companies with a market capitalization value of more than $10 billion), international equity asset class. As another example, Canadian bonds fall within the Canadian fixed income asset class. For the most part, there is very little correlation between different asset classes. Correlation is when one type of asset is doing poorly, another class is there to help the overall portfolio remain more stable and to grow. Broadly speaking asset classes have historically fallen into three categories: equities, fixed-income, and cash (or cash and cash equivalents). As investing has evolved, there has been a greater need to further group similar type investments. Understanding different risk and return characteristics, as well as an investment’s performance in any given market environment, has allowed investors to divide these general categories into more specific ones.
Defining Real Estate Income and Alternative Strategies
Real Estate Income is unlike any other investment as it offers a lower correlation to other asset classes. Solid long-term real estate investments get most of their income from rent, meaning its focus is on cash flow. Income from other types of equity, on the other hand, usually relies in part on hoping that the stock prices will go up. Since real estate is more about collecting rent than having the price of the building and land go up, it acts a lot like a bond. But since the owners of REITs are actual owners of those buildings and land, it is also a bit like equity, but less volatile in its price.
The second asset class we will look at is Alternative Strategies. The term “alternative strategy” is a catch-all term to categorize mutual funds with mandates that are not categorized into the conventional equities or fixed income asset classes. Commodities, private equity or venture capital, hedge funds, and even unusual real assets like toll roads, cell phone towers, and other similar types of property are examples that fall within the alternative strategy asset class category.
Why does CH use both?
Not only do real estate and alternative investing further diversify a client’s portfolio, but both offer clients the opportunity to earn more income directly from the cash flow of these investments rather than waiting for the price to go up. This means the mutual funds within both of these asset classes are deployed in client portfolios to generate cash, either to meet monthly client budget needs or in the form of reinvested rents and dividends, which then purchase more units of the mutual funds, allowing them to own even more real estate and alternatives. As an example, if the mutual funds earn a return of 6% per year but the fund’s price is down 4% for the year, our clients still earn 2%. This provides a “cushion” for the mutual fund, which thus protects our client’s capital.
CH uses Real Estate Income Trusts and Alternative Strategies to provide a “cushion” for clients’ portfolios and to diversify them with assets that have some of the best qualities of fixed income (cash flow), and stock ownership (price growth). By using diversification and cash flow we aim to protect our client’s capital and provide downside capture. If you’d like to discuss this further, please don’t hesitate to reach out to your advisor.
As always, we welcome any questions or comments.
All the best,
Devin Gorgchuck, Financial Advisor
& Your CH Financial Team