Finance 201: Different asset classes and their performance in different economic climates

Hi friends,

Welcome to the first part of my Finance 201 series. In the articles that are labeled under this series, I will assume that you already have a basic understanding of different financial instruments (bonds, stocks, ETFs, hedge funds). If not, do take a look at my Finance 101 series.

As the first part of this "higher level" series, I plan to at a closer look at the different portfolios of famous investors and I will be talking about their respective investment approach and their backtested investment returns. To do that, I felt that it is important for us to understand the performance of different asset classes in different economic climates (like recession, bull, or bear market). 

To do that, I will be looking at the correlation coefficient of their returns. For those that don't know what is a correlation coefficient, it is a statistical measure of the strength of the relationship between the relative movements of two variables.  Essentially, if I increase by 10%, you increase by 5%, and if I increase by 5%, you increase by 2.5% and if I decrease by 10%, you decrease by 5%, we would be positively correlated. When I change by a certain percentage, you would also change by a certain percentage. A negative correlation would just mean that if I increase, you decrease, if I decrease, you increase. This correlation coefficient is also a measure of a linear relationship.

The values of the correlation coefficient are from -1 to 1. -1/+1 would mean a negative/ positive perfect correlation. While 0 would indicate no correlation. 

First off, we will be taking a look at the long-term correlations between the assets (1960 to 2017), then we will take a look at the correlations in different specific economic climates. For the bull market climate, we shall look at 2010 to 2019. For the bear market climate, we shall look at 2007 to 2009 (Great Financial Crisis anyone?). I was hoping to find more data for the other recessions like the dotcom bubble and all that, but I can't seem to find it. Do let me know if you have access to any studies on it. 


Long-term correlation (1960-2017):


Across the board, with no distinction between upmarket and downmarket: 

Looking at the highlighted portion for Table 3 Part A,
Real Estates (Global Real Estates, Commercial, Residential, etc) has quite a strong positive correlation (0.73) with equities (stocks). 
Non-government bonds (think commercial bonds) has a mild positive correlation (0.52) with stocks Government bonds have a weak positive correlation (0.27) with stocks 
Commodities (Rare metals like Gold, Silver, Platinum) have no correlation (-0.04) with stocks

Looking at the downmarket (Where the price of the asset ends the year lower than the start of the year) highlighted in red, table 3 part B:

Real Estates have a strong positive correlation (0.76) with stocks
Non-government bonds have a weak positive correlation (-0.36) with stocks 
Government bonds have a weak negative correlation (-0.15) with stocks
Commodities have a mild negative correlation (-0.46) with stocks 

Hence, we can see that "safe haven" assets like bonds and commodities do exhibit different behavior in a downmarket compared to the average performance. They move into more negative correlations with stocks

Looking at the upmarket (Where the price of the asset ends the year higher than the start of the year) highlighted in blue, table 3 part B:

Real estates have a mild positive correlation (0.58) with stocks
Non-government bonds have a mild positive correlation (0.48) with stocks
Government bonds have a weak positive correlation (0.31) with stocks
Commodities have no correlation (-0.07) with stocks 

Hence, we can see that in an upmarket, the assets are more in line with long-term behaviors in table 3 part A. Except for Real estates, which moved towards a more negative correlation with stocks. 

Summary for this part (+ means more positive correlation with stocks, - means more negative correlations with stocks and 0 means almost no change):

                                   |Upmarket | Downmarket|
Real estates                 |       -       |         0         |
Nongovernment bonds  |      0        |         -         |
Government bonds       |      0        |         -         |
Commodity                  |      0        |         -         |

#ADMIRE MY GHETTO TABLE#

These are the long-term performance of these assets. 



Here we can see that the 20-years overlapping average correlation between the different asset classes with stocks and bonds.

We will now look at the bull-market correlations from 2010-2019:




We can make the following observations:
Investment-grade bonds have a weak negative correlation (-0.22) with US stocks
Commodities have a mild positive correlation (0.57) with US stocks
Global (All stocks in the world) stocks have a strong positive correlation (0.97) with US stocks
International (All stocks in the world except the US) stocks have a strong positive correlation (0.87) with US stocks
REITs have a mild positive correlation (0.65) with US stocks

Here we can see that this is in contrast with our previous data. This is where I will need to clarify that the 2010 - 2019 is actually an anomaly, as it was the longest bull-market that we have ever seen. So you will need to take note of this observation. Furthermore, an upmarket year in the first part means that a rise of 0.1% would still constitute as an upmarket. While 2010-2019 was upmarket on steroids, with consecutive upmarkets. Hence, I felt a need to look specifically at a bull-market period rather than an upmarket year

Let us take a look at the performance in turbulent times (2007-2009) during the Great Financial Crisis (This is different from the down market, as it represents a significant downmarket. This is in contrast to part one where a 0.1% drop in market price between the start and the end of the year would mean a downmarket)


We can make the following observations: 
International stocks have a strong positive correlation with US stocks
Emerging market stocks have a strong positive correlation with US stocks
REITs have a strong positive correlation with US stocks
Commodities have a mild positive correlation with US stocks
High yield bonds have a strong positive correlation with US stocks
International bonds have a mild positive correlation with US stocks

Hence, we can see this dragging effect of stocks for the majority of the financial instruments especially in times of volatility, with all of them having a positive correlation with stocks. 

I honestly did not expect this behavior. However, there is a limitation as there are no correlations between stocks and US bonds... 

With that, I hope that you can have a good understanding of the different correlations of different assets in different economic conditions. It was certainly beneficial to me. hahaha

With that, 
I end today's topic. 

Stay vested, Stay frugal my friends,
Dionysius

Sources:
https://www.guggenheiminvestments.com/mutual-funds/resources/interactive-tools/asset-class-correlation-map
https://www.vanguard.co.uk/documents/adv/literature/dynamic-correlations.pdf
https://academic.oup.com/raps/advance-article/doi/10.1093/rapstu/raz010/5640504

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Finance 101: What is a portfolio?

Hi friends, 

I bet that you have heard of it before. "I have a portfolio of blah blah blah", or "How big is your portfolio?" So... What is this "portfolio" that everyone who is investing/ planning their finances is talking about? Today I shall be tackling this question:

Definition:
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly tradable securities, like real estate, art, and private investments. - Investopedia

A portfolio refers to a collection of investments or financial assets held by an individual, investment company, financial institution or hedge fund. This grouping of financial assets can include everything from gold and property to stocks, bonds, and cash equivalents. In essence, an investment portfolio acts as a big briefcase-carrying all of these financial assets. - Capital

These are the essential points.

1. Group of financial assets (Financial instruments that can be anything that we discussed and more, like real estates, arts, whiskey, etc)

2. Held by an individual, company, funds. 

For today, we will be talking about your individual portfolio. As per the definition, your portfolio is a combination of the different financial instruments that you are holding. A portfolio is also something that you should build based on your preferences. It should be in line with your investment beliefs and your risk appetite

Here are some of the things you should consider before setting off to build your portfolio:

1. What is your risk tolerance? 

How much gain/loss are you able to tolerate? Are you ok with a portfolio that can give you large returns and losses?

2. What is your time horizon?

A longer time horizon would mean that you can create a portfolio that has a higher potential for appreciations. 

3. What assets are you comfortable/ familiar with?

If you are competent and have a lot of experience with a particular financial instrument, you can consider having more of your portfolio allocation to the instrument that you are familiar with. 

Here are some of the financial instruments that you can have in your portfolio. We have actually gone through the majority of them in the other Finance 101 articles:

1. Stocks, etfs, mutual funds, index funds, Reits 

2. Bonds, bond funds

3. Gold, precious metals

4. Crypto (Bitcoin, ethereum)

5. Real estates 

6. Other financial instruments like alcohol, art, etc

7. Commodities like copper, steel, oil

8. Insurance

As we are talking about the personal portfolio, in which I would assume that you do not have the need to invest in commodities, alcohol, art etc. We will focus on 1,2,3,4,5,8 I will analyse it from the POV of a) Aggressive investors (with a long time horizon) b) Conservative investor (with a shorter time horizon) c) Investor who is looking to pass intergenerational wealth d) ultra-aggressive investor

Do note that the allocations are just for example. You should do your own research. 

a) Aggressive Investor (For those who wants :

1. Stocks (85% in etf, individual stocks)

2. Bonds (0%)

3. Precious metals (4% in gold)

4. Crypto (1%, treat it as a gamble)
5. Real Estates (5%)

8. Insurance (5%, to protect against sudden events)

b) Conservative Investor (For those who wants to have some returns but cannot take too many losses)

1. Stocks (20% in etfs, and reits etfs)

2. bonds (60% in bond funds)

3. Precious metals (5% in gold)

4. Crypto (0%)

5. Real Estates (5%)

8. Insurance (10%)

c) Generational Wealth Investors (For those who wishes to pass to their offsprings without incurring taxes)

We do not have inheritance tax in Singapore. But do know that if you pass on properties, your offsprings might need to pay property taxes on it, or pay for the maintenance fees. 

Hence, you might want to consider holding on to stocks and bonds. 

d) Ultra-aggressive Investors (me, with about 30-40 years of investing)

1. Stocks (95% in etf, individual stocks/ reits)

2. Bonds (0%)

3. Precious metals (0%)

4. Crypto (0%)
5. Real Estates (0%)

8. Insurance (5%, to protect against sudden events)

I will reiterate this again. Your portfolio would be reflective of your investment beliefs. Your portfolio should be tailored to your needs. Of course, with a portfolio, you should always look at it every now and then to rebalance it. The rebalancing would allow your portfolio realigned with your chosen allocations. This rebalancing should be around once per 3 months. 

As always, do take note that the allocations are just examples, you should always do your own research before making any financial decisions. 

Also, now that we have settled a majority of the financial instruments, I will be moving on to the most famous financial portfolios that are held by famous investors like Warren Buffett, Ray Dalios, etc. It will be named "Finance 201". I am an Engineer for goodness sake. How creative do you think I am :')  Don't worry. Finance 101 series will still run on, just keep sending in request so that I know to explain some of the basic terms that I have used in my posts

With that, 

I end today's topic

Stay vested, Stay frugal my friends,

Dionysius

Sources:
https://capital.com/portfolio-definition
https://www.investopedia.com/terms/p/portfolio.asp

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Finance 101: What is a Real Estate

Hi friends, 

Today I will be writing about something that is on a lot of our minds in Singapore. Similar to REITs, just that it is something on a personal level and not managed by anyone. It is real estate. 

So...... just some fun facts:
1. Almost half of Singaporeans (2.18 million out of 5 million) are in the world's richest 10%, 226,000 (5%) people are in the 1%
2. For the year 2019, the average Singaporean has US$300,000 in their name, with US$150,000 in real estates
3. The median has about US$100,000. 

As you can already infer, with our small land-size, if we were to include the house that we are living in into our asset calculations, a lot of Singaporeans would be classified as rich on a global standard. The average price of private property in the city is US$874,372. The average of public housing (3-rooms) is around US$200,000. Hence, it would be correct if I were to say that majority of our wealth is locked up in properties. 

But, I would say something that goes against what you believe in. You can only treat something as an asset if it brings you income (by increasing in value and you selling it or by renting it out). Hence, if you are not going to sell/rent the house that you are currently staying in, it is not an asset. That is your personal property.

For subsequent parts of this post, I will be treating real estate/properties as an asset, that means, you are renting it away or planning to sell it. These can be commercial properties (like those shop units that you can rent/sell to shops/offices) or residential properties (those that you rent out to tenants or sell) or industrial properties (warehouses, factories)

So.. What is a real estate?
Investment real estate is real estate that generates income or is otherwise intended for investment purposes rather than as a primary residence. It is common for investors to own multiple pieces of real estate, one of which serves as a primary residence while the others are used to generate rental income and profits through price appreciation. - Investopedia

So essentially:
1. Real Estate is an investment only if you are selling it or to rent it out 
2. If you are using it for residential purposes, it is not an investment.

So now that we know what a real estate is, let us take a look at the advantages and disadvantages of it and compare it to REITs as well:

Advantages of owning real estates:
1. Leverage (Purchasing a Real Estate would often mean that you can borrow money from the bank. For example, a property is valued at $1,000,000, you would just need to pay the downpayment of 10% to own it.)
2. Stability (This is especially evident in Singapore. Due to our small size and relatively dense populations, it would be safe to assume that there will always be a demand for housing. Hence, the prices of properties in Singapore have been steadily increasing. Even for public-housings)
3. Cashflow (Imagine just sitting there and receiving rent payment from your tenants. Quick passive income)
4. Diversification (Historically, real estates have shown to be negatively correlated to other financial instruments)

Disadvantages of owning real estates:
1. Taxes and transactions cost (Property taxes, stamp duties, income taxes from rents, ABSD)
2. Liquidity (It takes a while for properties to be liquidated. This is especially significant if you require money in a short span of time.)
3. Tenants and ongoing expenses (People that you rent to may default on their rents due, plus you are responsible for the maintenance cost of the property)
4. Fluctuations in market (Economic conditions would affect the market demands and hence prices of your properties)
5. High entry barrier  (You can't buy Real Estate with a $1000 capital, but you can buy other financial instruments with that sum of money) 

Now you would question: Wow, Real Estates sounds like REITs. So let's compare the two of them. 

Real Estates better than REITs:
1. You make your own decisions on where or what properties to invest (REITs decide on what properties to invest in)
2. Higher leverage compared to REITs (In Singapore, REITs are only able to have a leverage ratio of 50%)
3. Better cashflow (You receive rent every month, rather than the quarterly dividends paid by REITs
4. No management fees (You have to pay for the professional management of the properties)

REITs better than Real Estates:
1. Better liquidity (REITs are traded on stock exchanges, hence, liquidation is within a day)
2. More diversification (REITs normally owns more than one property. This higher number of holdings would mean a better diversification.)
3. Lower barrier to entry (REITs cost lesser than Real Estates to own)
4. Professional management (There are people managing the properties for you)

Criteria to look for in a good real estate:
1. Location (This is important if you wish to rent out your properties)
2. The future prospects of the property area (Are there going to be amenities, malls, business development, that are going to build in that area? If you can foresee that the area has a high demand in the future, it has high appreciation potential)
3. Timing (This is important for properties, as property prices are still tied to economic conditions)

Thoughts and comments:
I believe that Real Estates do play a significant portion in our financial portfolio. Especially in Singapore where we have such a small land supply. However, due to the high barrier of entry and the property taxes, I am unable to afford them in my portfolio at the moment. I believe that as I get old and want a conservative approach to my investments, I would move more portions of my portfolio to real estate.  

Personal Portfolio:
$0 in real estates

With that, 
I end today's topic. 

Stay vested, Stay frugal my friends,
Dionysius

Sources:
https://www.statista.com/statistics/785044/singapore-number-of-millionaires/
https://www.businessinsider.sg/half-of-singapore-is-in-the-worlds-richest-10-and-226000-people-are-among-the-elite-1
https://www.todayonline.com/singapore/singapore-worlds-second-most-expensive-housing-market-cbre-report
https://www.hdb.gov.sg/cs/infoweb/residential/buying-a-flat/resale/resale-statistics#pdurrentresalestatsmedianresalepricesforregisteredresaleapplications13838002997481
https://www.investopedia.com/terms/r/realestate.asp
https://www.investopedia.com/articles/investing/072314/investing-real-estate-versus-reits.asp

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Finance 101: What is a REIT?

Hi friends,

I shall be talking about something that is considered safe and value would never fall in a country with a limited supply of land: Properties, more specifically; Real Estate Investment Trusts (REITs):

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate. Modeled after mutual funds, REITs pool the capital of numerous investors. This makes it possible for individual investors to earn dividends from real estate investments—without having to buy, manage, or finance any properties themselves. - Investopedia
When you invest in a real estate investment trust (REIT), your money is pooled together with other investors' in a collective investment scheme that invests in a portfolio of income-generating real estate assets such as shopping malls, offices, hotels or serviced apartments. - Moneysense.gov.sg

As we can see from the definitions, the keywords are:
1. Owns real estate 
2. Pool the capital of other investors - Similar to ETFs and mutual funds
3. Income-generating investments - The income is generated from the rents paid by the tenant of these real estates 

So.. What is a REIT? 
Essentially, the trust managers would take the money gathered from a pool of investors, to buy properties like malls, office buildings, hospitals, etc. The spaces are leased out to tenants (think of shops in a shopping mall - Uniqlo, h&m, texas chicken). The profits from the rent collected after paying off the loans and fees borrowed to buy the properties are then distributed to the unitholders (similar to stockholders receiving investments). This is called distribution yield.

Here are the sectors that a REIT may specialise in:
1. Retail: (Shopping malls):

This is the most common one in Singapore, however, it is also easily affected by economic conditions. In a downturn like 2020, there might not be visitors to a mall and the tenants may default on their rents. A strong REIT would be one with a lot of stable tenants (think big brands) that can afford to pay the rent during an economic downturn and good foot traffic.  

2. Hospitality (Hotels, some residences)

This also easily affected by economic conditions, in a downturn like 2020, where there are basically no tourists, hospitality REITs are at a disadvantage as they no longer have any income. Hence, they will experience more volatility because of external market conditions. 

3. Commercial (Office buildings)

Commercial REITs are relatively more stable as the lease agreements with the tenants are longer in duration. Also, if the tenants are majority larger and more stable corporations, even in an economic downturn, the inherent income of the REIT would not be affected. 

4. Healthcare (Hospitals, nursing homes)

Healthcare REITs are expensive in Singapore. This is as Singapore is facing an aging population, we expect an increase in the demands for quality healthcare in the future. Singapore is also positioned as a location for quality healthcare for the region and investors know about it. 

I would say that healthcare REITs are stable, provided they have the proper management and loan ratio. 

5. Industrial (Data centers, warehouses, logistics buildings)

Industrial REITs are dependent on the type of industries that they cater to; some industrial REITs may focus on logistics buildings and when imports are not doing well, they would be negatively affected. 

However, they are also more stable as the lease agreements are also typically longer. 

Advantages of REITs:
1. Diversification (You would be investing in more than 1 property most of the time)
2. The steady stream of income through distribution yield (Passive income)
3. The gradual increase in property value (Especially relevant in land-scarce Singapore)
4. Liquidity (As Reits are sold on the stock market, transaction can occur immediately)
5. Low cash upfront (As compared to owning actual properties)

Disadvantages of REITs:
1. Exposure to only one sector (As a REIT usually focus on one sector, you would be exposed to the downside of the sector in certain economic conditions)
2. Management fees (As REITs are actively managed, fees are required to pay for their expertise)
3. Volatility (As a REIT is traded on the stock exchange, it is subjected to fluctuations of the stock market)
4. Subjected to changes in interest rates (Reits are allowed to borrow up to 45% of their total assets in Singapore, changes in interest rates might negatively affect the operations of these Reits) 

How to consider a REIT:
1. Gearing ratio - The ratio of loans to asset, a low gearing ratio would allow the REIT to take advantage of lower property prices in an economic downturn. 
2. Management team - A good management team would make the correct decisions, such as increasing the gearing ratio when property prices are cheap
3. Outlook on the sector/ industry and the properties - If you think that over the long run, the specific sector will not do well, you should probably avoid, likewise for the price of the property that the REIT is managing
4. Occupancy Rate - A higher occupancy rate would mean that there are more distribution yield 
5. Tenants retention rate - A higher retention rate would mean more tenant are willing to continue their lease with the property
6. Fees - High fees would definitely dig into your returns. But if you're paying for the right team to deal with rationale tenants, unlike mutual funds, you would get return for your money 
7. Distribution yield - A history of consistent distribution yield could be an indicator that it will continue to pay out the same distribution yield in the future. 

Thoughts and comments:
For my personal portfolio: I have about half in REITs through my REITs ETF at the moment. If the price of the ETF is to keep falling, then I may consider increasing my weightage to take advantage of the low price. I love the idea of collecting passive income as a landlord. kekekeke. 

Do your own due diligence when it comes to investing, I am not recommending you to buy anything. 

With that, 

Stay vested, Stay frugal my friends, 
Dionysius




Sources:
https://www.investopedia.com/terms/r/reit.asp
https://www.drwealth.com/singapore-reits/
https://www.moneysense.gov.sg/articles/2018/10/understanding-real-estate-investment-trusts-reits

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