From a small northwestern observatory…

Finance and economics generally focused on real estate

ACCRE Mid-Month Report, August, 2020

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Diversification is an oft-misunderstood thing. In an individual business, diversification is generally not a good idea. Internal to the business, there is an old saying, “To Dominate, Concentrate”. Indeed, few businesses have succeeeded in more than one line of businesses (Microsoft, General Electric, and to an extent Apple are among the rare exceptions). External to the business, investors like to see an individual firm concentrate in a very narrow field. That’s a function of the way common stocks work. If I invest in a firm, and it succeeds, I reap the rewards, but if it fails, I only risk what I’ve invested. Heads I win a lot, tails I don’t lose that much. This may be the core secret to why capitalism works so well.

But in a portfolio of investments, we want diversification, for two somewhat different reasons. If I pick 10 stocks at random, and half do well and half do poorly, I will be better off, from a probability perspective, than most managed funds. (The writer, Andrew Tobias, demonstrated this on television back in the 1970’s with a monkey throwing darts at the WSJ stock pages.) This explains the popularity of index funds. Second, if I have a well diversified portfolio, then the ups-and-downs of the various stocks will attenuate one another. My overall portfolio value will rise over time, but without the major swings of the individual components.

Now, that brings us to real estate (and my mid-month report). While it’s been well known and understood for many years that real estate is a great diversifier for portfolios, few investors — even the most sophisticated ones — understand how to take advantage of it. In my experience, the majority of investment advisors know very little about real estate, and hence steer their clients away from it (to the detriment of their clients!).

Anyway, ACCRE continues to outperform the benchmarks both on absolute terms (as noted in our end-of-month report) and on a risk-adjusted (Sharpe Ratio) level. Further, our correlation to the S&P is still right where we want it — in the positive direction, but well under 100%.

S&P 500:
Average Daily Excess Return0.0308%
Standard Deviation1.3537%
Sharpe Ratio2.2727%
Average Daily Excess Return0.0526%
Standard Deviation1.1405%
Sharpe Ratio4.6079%
Correlation (overall):56.3606%
Correlation (monthly):57.3961%
ACCRE Metrics as of July 31, 2020

The average daily excess return is the daily return minus the t-bill returns for that day. (For consistency, we use the coupon-equivalent daily T-bill price as promulgated by the U.S. Treasury.) The Sharpe Ratio is simply that daily return minus the standard deviation, thus adjusting for volatility risk.

As we’ve noted repeatedly here, these are complicated times for both real estate and investing as a whole. A well-curated real estate portfolio can provide above-average returns, diversification, and risk attenuation. If we can answer any of your real estate questions, please let us know.

Written by johnkilpatrick

August 17, 2020 at 9:20 am

Posted in Uncategorized

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