Balance real and financial assets to maintain a healthy portfolio.
Byline: Sean Kelleher, Special To Gulf News
Last week's space covered the 'tick' on the MSCI, which now looks like a 2009 gain of over 30 per cent for global emerging market equities, and over 12 per cent so far for the 'mature stuff'. The 12 per cent and 30 per cent represent the upturn of the tick following a massive 2008 fall. Great news for investors who started their careers on January 1 this year. The problem for everyone else revolves around where they are today versus where they were and what to do about it.
Here's the answer - diversify. Okay, I know you know. You may also know that diversification itself is a pretty hefty subject. However, a recent presentation by Castlestone Management, specialists in commodity funds, makes a very sane point. Specifically, that one of the more significant considerations within the subject of diversification is balancing your collection of 'financial assets' with a portion of 'real assets.
Their Aliquot aliquot (al-ee-kwoh) adj. a definite fractional share, usually applied when dividing and distributing a dead person's estate or trust assets. (See: share) collection of 'real' funds give a clue on what they consider 'real' to be, as it includes funds vested in agriculture, commodities, gold bullion Gold bullion
Investment-grade, pure gold, which may be smelted into gold coins or gold bars. and precious metals Precious Metals
Valuable metals such as gold, iridium, palladium, platinum, and silver.
Investing in precious metals can be done either by purchasing the physical asset, or by purchasing futures contracts for the particular metal. , although some experts believe property and arts could be thrown into this mix.
Back to the point: one of the more obvious diversification decisions of today is the balance between real and financial assets Financial assets
Claims on real assets. . Castlestone quotes the Harvard Endowment compositions from the early 1990s which demonstrate that their strategies have emigrated from a traditional diet of 'financial-only-assets, that is, cash, fixed income and bonds; to a trendy 21st-century, fast-thinking, active management style which mixed the traditional with private equity; alternative strategies as well as the 'real' world of commodities, properly and even art.
Herein lies a story that Castlestone (quite rightly) brought up: the growing value of 'real' assets within a portfolio during 'normal markets' as a means of diversification. Although it hides the fact that Harvard itself was guilty of trendy innovation to the point of supporting (and leveraging on) assets that became highly illiquid Illiquid
An asset or security that cannot be converted into cash very quickly (or near prevailing market prices).
A house is a good example of an illiquid asset.
See also: Cash, Liquidity
In the context of finance. during downturns. Lesson number one on the difference between a 'financial asset' and a 'real asset' - at least you have capital markets to sell into with financial assets.
The Harvard Endowment is a beast of a portfolio. Reckoned to be around $36.9 billion (Dh135.42 billion) in value, it generates something like $1.4 billion in revenue for brainy Americans to keep their educational costs down. The Harvard Endowment is (or maybe was) a litmus-test for portfolio planning, it was the envy of the endowment world - its decisions were seen as both daring and streets ahead. But then 2008 happened, and it couldn't sell enough of its falling portfolio because the sellable 'financial assets' were an underweight Underweight
An situation where a portfolio does not hold a sufficient amount of securities to satisfy the accepted benchmark of the portfolio's asset allocation strategy.
Notes: section of the portfolio.
Unfortunately, they were overweight on exotics: private equity, commodities like timber, and hedge funds. Leveraging, or paying six per cent on assets that were in negative non-sellable positions didn't seem so brainy. Like many ultra-wealthy portfolios, 2008 did them in.
So, perhaps one of the more pertinent parts of Castlestone's message is that they do not see their offering as anything that should dominate portfolios. They do, however, see their offerings as something that should be within every portfolio. Revolving their marketing around the difference between 'financial' and 'real' assets therefore has some merit where the net conclusion revolves around balancing the two.
What then is a 'financial asset'? To approach this, consider at the outset what a 'fair value' of equity is. The fact that equities are often priced as a 'future' distort the picture. In other words Adv. 1. in other words - otherwise stated; "in other words, we are broke"
put differently , if I buy Microsoft shares today, I buy on the basis that value will rise in the future. I buy on the basis that the current price is 'fair value', and that the current price entails all that is known about the share (American economist Eugene Fama's Efficient Market Hypothesis Efficient Market Hypothesis
States that all relevant information is fully and immediately reflected in a security's market price, thereby assuming that an investor will obtain an equilibrium rate of return. ).
The trouble with this thinking is it is prone to what businessman Warren Buffett Warren Buffett
Known as "the Oracle of Omaha," Buffett is Chairman of Berkshire Hathaway and arguably the greatest investor of all time. His wealth fluctuates with the performance of the market, but for the last few years he has been reported to be worth over $30 billion, making calls 'Mr Market' which can be overzealous and under-zealous as the herd instinct Herd Instinct
A mentality characterized by a lack of individuality, causing people to think and act like the general population.
This term is used in the investing world to refer to the forces that cause unsubstantiated rallies or sell-offs. takes control of the price. For Buffett the solution is simple - work out what the 'fundamentals' are and work on establishing what 'fair value' really is and buy stocks only if they are under 'fair value' and hold them as they increase their value.
What then is a real asset? Essentially, "real" often equates to being both 'fungible' and tangible. As such, real assets Real assets
Identifiable assets, such as land and buildings, equipment, patents, and trademarks, as distinguished from a financial investment. are less prone (but not immune from) the herd instinct driving prices up or down. Certainly on the downside there is more protection.
In many respects the 'real world' has a more tangible check on prices. There is no point in paying more than what you need to. With financial assets the point on when you are over-paying is more obscure. It doesn't make 'real assets' more rewarding, and it doesn't make them safer bets. It does, however, make them different to financial assets and that, in itself, is one of their greater allures.
- The writer is chairman of Financial Partners/Mondial
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