In the 1950s American economist Harry Markowitz opined that diversification was the only “free lunch” in investing: a reference to the role of the tactic in protecting returns and building wealth for no additional financial outlay.
The Nobel Laureate may have changed his mind after witnessing the hedonistic vibe of the 1980s, when business lunches on someone else’s dime extended well into the evening. Nonetheless, the basic tenet of diversification as a protector of wealth holds true today – if not more so.
In building and guiding a client portfolio, any diligent financial adviser will have diversification strategies on their checklist. After all, piling wealth into a single asset class is contrary to acting in the client’s best interest – unless there’s a valid reason to do so.
The trouble is that diversification often does not go much further than ensuring a mix of mainstream equities, bonds and cash. Australian investors, in particular, are heavily biased to a small cohort of dividend-paying blue chip stocks (courtesy of the dividend franking system).
They’re also heavily weighted to traditional property, via their rapidly appreciating family home.
Risk-conscious retirees also hold billions of dollars in bank deposits earning derisory interest well below the inflation rate.
Often diversification fails because when one of the major asset classes implodes, the others can be dragged down as well, despite the supposed lack of correlation.
For example, shares and bonds are meant to move inversely to the other, creating a hedging effect in choppy markets.
But it doesn’t work all the time: in 1994 bond values and equities fell in unison, with interest rates rising sharply in response to global economies recovering from recession.
As listed vehicles, and thus easily bought and sold, the ever-popular exchange traded funds (ETFs) can be vulnerable to share market corrections even if their underlying asset is a commodity that has nothing to do with equities.
Gold is famed as a safe harbour and a store of value. Yet the bullion price has been under pressure for some months, despite the prospect of renewed inflation in the US.
True diversification means thinking beyond the traditional share, bond and direct property classes to overlooked variants that deliver attractive returns without presenting undue risk.
Although no portfolio is a ‘one size fits all’ situation, it’s important that advisers at least be cognisant of the options that may suit their clients’ needs.
The list of possibilities is limited only by the boundaries of imagination and the advisory group’s research capabilities. Infrastructure, rural land, renewable energy and first-security mortgage loans are all assets that have generated superior returns in recent years.
But how do investors gain access to these assets, which are often hard to reach or require minimum investment amounts beyond the reach of the ordinary Australian?
One proven way is via the fractional investing model, which has considerable benefits for investors and advisers alike.
Under a fractional, or ‘syndicated’ model, investors can own a share of a property or project previously only available to sophisticated investors.
For an outlay of as little as $1,000, the investor owns a direct equity stake in a property they would not usually be able to be exposed to.
Typically, assets such as corporate bonds and energy projects entail high transactional cost. Under the syndicated model these costs are spread across myriad investors.
For self-managed super funds, the fractional model enables the entity to leverage without the need to establish a bare trust (an intermediary to hold the property until the loan is repaid).
For advisers, the fractional model also enables them to create in-house syndicates giving them the ability to control liquidity from within their own client base. By using the platform, advisers can also differentiate themselves with the ability to offer a broader range of investments.
Advisers can also create their own investment sub-funds or syndicates in many different areas, including property development projects
One example of the fractional model adding value is with housing accredited under the National Disability Insurance Scheme (NDIS). These properties have generated yields of 8 per cent or more, compared with a return of perhaps 3 per cent on typical investment housing.
Rural farmland values have boomed: According to Rural Bank’s annual report on farmland values, the median price of Australian farmland rose 12.9 per cent in 2020, the seventh consecutive year of growth. Farm values have increased at a compound annual rate of 7.6 per cent over 20 years.
Given the ESG (environmental social and governance) mandates adopted by most global fund managers, capital is pouring into renewable energy schemes. Once again, returns have been highly attractive.
Via the ASX-listed Domacom (ASX: DCL), investors had the opportunity to own part of the Sapphire Wind Farm, a 270-megawatt project in the New England region (and the largest such project in NSW).
Syndication can work in leisure assets such as motels and hotels, or commercial assets such as storage facilities.
As well as facilitating diversification strategies, the fractional model also offers inter-generational planning opportunities. For instance, home equity release arrangements can help children scale the property ladder while freeing-up income for their ageing parents.
Of course, due diligence is always paramount when it comes to acquiring assets for a syndication proposal. All fractionalised assets are subject to legal review of the contract of sale, with established assets subject to an inspection and property management overview.
Development-stage projects are subject to comprehensive financial modelling.
No client will benefit from an ad hoc or headstrong approach to asset allocation – especially when the road is less travelled.
But to satisfy a client’s best interests to start with, it’s vital that advisers are at least across all the options that exist.
To further the ‘free lunch’ analogy, no self-respecting chef will turn up to work without the full set of knives.