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Investing in Alternatives – Part 1

Over the last few weeks we have covered the major asset classes that investors include in their portfolio, namely cash, bonds, shares and property.

Over the last few weeks we have covered the major asset classes that investors include in their portfolio, namely cash, bonds, shares and property.  “Alternatives” is an all- encompassing term that includes anything else.  

This week we look at one of the most well known Alternatives, commodities.

Commodities

Some people like to include exposure to commodities within their portfolio, the most popular with non-professional investors tend to be gold and oil.

What:  Commodities are tradeable goods.  Commodities include metals (e.g. silver, gold), energy (e.g. oil), livestock (e.g. pork bellies) and agriculture (e.g. coffee, corn).

Why:     People invest in commodities due to a view they have on the market.  For example, if you believe that pork bellies are undervalued, then you need to get out more and stop researching the price of pork bellies!  Or you could try investing in them to benefit when the price rises. 

Other commodities, notably gold, are used to express a view about risk.  Generally when global risks increase, the value of gold increases because it is an absolute store of value.  That is, it has value in and of itself, and in times of crisis the price of gold rises.  During the period from 2007 until the end of 2010, the price of gold increased at an average annual rate of c.23%.

How:  Generally speaking, it is quite difficult to invest in commodities directly, because they trade in very large parcels that make it hard for retail investors to participate.  The easiest commodity to invest in directly is gold.  For example, if you want to go old school you can head to the Perth Mint and buy yourself some gold coins.  Other commodities, like oil, are a little harder to buy and store directly.

The easiest ways to invest in commodities are:

  • Share Purchases:  Although you cannot purchase all commodities directly, you can directly purchase shares in a company that trades in that commodity.  For example, to get exposure to gold you could invest in a gold mining company.

  • Passive Funds: There are exchange-traded funds available that will give you exposure to commodities, e.g. a Gold ETF or an Oil ETF.  The price of these ETFs will rise when the price of the underlying commodity rises, and vice versa. 

  • Managed Fund:  There is also the possibility of investing in a managed fund, where the manager specialises in a particular commodity. 

Risks:  Investing in commodities is purely a price play, you will only benefit if the price of the commodity increases.  Unlike shares, bonds or property, there is no income component of commodity investing (i.e. you do not receive a dividend, interest payment, or rent). 

Commodity investing can be complex and the prices are very volatile.  The people that trade and invest in commodities are highly specialised, for example the people that invest in gold do it day in and day out, for their whole career.  It is not an asset class that is recommended for novice investors.

If you want to invest in commodities, then ideally it should form only a small part of your portfolio (e.g. 5%) due to the risks, complexity and specialised knowledge required.

Next week we are going to look at another common Alternative, Private Equity.

 The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs before acting on the advice.

Stepping on to the property ladder

Now that we’ve looked at some of the benefits, and risks, of investing in property, it’s time to consider how to invest.

Now that we’ve looked at some of the benefits, and risks, of investing in property, it’s time to consider how to invest.

How can I invest in Property?

There are a number of ways to invest in property, below we consider some of the most common.

Directly 

This is the road many people go down, purchasing a property for investment purposes.  Purchasing directly allows the owner to take advantage of negative gearing, it also allows you to choose and inspect the property yourself. 

The tax benefits need to be weighed against some of the downsides:

  • You need a lot of money to enter the property market, unlike the share market where you could start with a very small (e.g. $100) initial investment amount.
  • The purchase costs can be high (including the deposit, inspection costs, solicitors’ fees and stamp duty).
  • The ongoing management costs are high, including agent’s fees and maintenance costs.
  • By investing in one property in one location you are putting all your eggs in the one basket and concentrating your risk in that location
  • You can’t sell part of a property, it is either all or nothing.  Whereas with an investment in shares, you can sell part of your investment portfolio.

Indirectly via shares

Instead of buying directly into property, it is possible to get access to the property sector by buying the shares of companies that operate in the property sector.  This could include companies involved in property development, real estate management, or the supply of building materials.  Investing in the shares of property companies will not allow you to gain all the benefits we outlined above, but it is an option worth considering if you do not yet have the funds to purchase a property.

Exchange Traded Funds

There are a number of passive funds that provide access to property, including ETFs that focus on different classes of property (e.g. office, shopping centres, industrial).  The benefit is that you get access to a diversified portfolio, however the downside is that you do not get the benefit of negative gearing, or the security that comes with personally owning a tangible asset.

Unlisted Managed Funds

Another option is paying a fund manager to invest in property.  Property managers generally specialise in one particular area, whether it be residential, or commercial, or industrial property.  The downside is that this will cost you between 1-2% p.a, and you do  not get the benefit of negative gearing, or the security that comes with personally owning a tangible asset. 

REITs

A REIT is a real estate investment trust and provides a way for investors to access property investment, without having to purchase the entire property.  The real estate investment trust owns and manages the property, and the investor gains access to the assets of the trust through a purchase on the Australian stock exchange. 

Each REIT usually has a particular investment focus, e.g. shopping centres, office buildings.  The performance of the REIT is dependent on the skills of the manager who is picking the underlying assets and managing them, it also depends on the amount of debt the REIT has, higher debt leads to higher risk.  Before purchasing a REIT, make sure you do your due diligence on who manages the REIT and the financial position of the REIT.

Another point to note regarding REITS is that although they might feel more liquid because they trade on the stock exchange, REITs are still exposed to property and the underlying investments can be illiquid.  A number of REITs were frozen (i.e. you couldn’t get your money out) during the GFC.

According to the SPIVA report  over 75% of actively managed Australian REITs under performed the passive index over the last 10 years.

So there you have it, a number of options for you to consider if you feel that property is an area you would like to invest in.  Next week we’re moving on to the exciting, and all-encompassing world, of “alternatives”.

The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs before acting on the advice.

Property Q&A

The property market has outperformed the share market over the last 10 years, so why not jump straight in?  This week we look at the risks of investing in property.

What are the Risks of investing in property?

There are lots of benefits to investing in property, but make sure you understand the risks before making what is likely to be the largest investment decision of your life.  Below we take a look at the key risks.

Liquidity: We have spoken about liquidity previously, it refers to the ability to turn assets into cash.  Shares are very liquid because they can be sold on any business day.  However selling a property can take some time, if the market is falling it is very hard to get out quickly.  Once the market has fallen, it can take years to sell certain kinds of properties (e.g. rural / remote properties, bespoke properties, commercial buildings that no longer have tenants).

Also, when selling property it is all or nothing, you can’t just sell part of it.

Volatility:  Property is classed as a growth asset, not a defensive asset (which include cash and bonds) because property values are volatile.  The volatility of the share market is very apparent, because the prices move all day every day, and there is clear visibility of the share price movements.  The property market is also continually moving, there is just less transparency around pricing, and therefore less visibility of the movements.   A study found that the standard deviation (a measure of volatility) of direct property investing over the period from 1985 to 2012 was close to 10%, compared to 20% for the stock market.  This data suggests that property investing is less volatile than investing in the stock market, however volatility is still present.

Leverage: One of the benefits of investing in property is the ability to borrow money to do so, which allows you to leverage you initial investment to purchase a more expensive property than you could afford without borrowing.  The downside of leverage is that it introduces additional risk.  If you invest $50,000 in the stock market, the most you can lose is $50,000.  If you use $50,000 as a down payment and borrow $400,000, then you get an asset worth $450,000, however you now owe $400,000 to the bank and are personally liable for making sure the money gets repaid.

Lack of diversification:  Due to the large cost of purchasing property, it is difficult to create a diversified portfolio by investing directly.  If you own only one residential investment portfolio, you are heavily dependent on the performance of that geographic location, which means a very concentrated portfolio.  This issue can be overcome by investing via a fund, however then you do not have direct ownership or control over the asset, and are unable to benefit from negative gearing.

Management Costs: Investing in property comes with high management costs for the owner of the asset.  This includes agents fees, maintenance costs and other running costs (e.g. utilities, council rates, land tax).  These fees tend to result in much higher management costs for a property portfolio than a share portfolio.

What goes up must come down: There has been a lot of talk in the press about the Australian market being over-valued.  Whatever your view, it is worth remembering that market conditions change; house prices will eventually come down, and interest rates will eventually go up.  Here’s a good overview of the last housing crash, including interest rates of 17.5% – yikes!

 The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs before acting on the advice.

What are the risks of investing in property?

The property market has outperformed the share market over the last 10 years, so why not jump straight in?

The property market has outperformed the share market over the last 10 years, so why not jump straight in?

This week we look at the risks of investing in property.

What are the Risks of investing in property?

There are lots of benefits to investing in property, but make sure you understand the risks before making what is likely to be the largest investment decision of your life. Below we take a look at the key risks.

Liquidity

We have spoken about liquidity previously, it refers to the ability to turn assets into cash.  Shares are very liquid because they can be sold on any business day.  However selling a property can take some time, if the market is falling it is very hard to get out quickly.  Once the market has fallen, it can take years to sell certain kinds of properties (e.g. rural / remote properties, bespoke properties, commercial buildings that no longer have tenants).

Also, when selling property it is all or nothing, you can’t just sell part of it.

Volatility

Property is classed as a growth asset, not a defensive asset (which include cash and bonds) because property values are volatile.  The volatility of the share market is very apparent, because the prices move all day every day, and there is clear visibility of the share price movements.  The property market is also continually moving, there is just less transparency around pricing, and therefore less visibility of the movements.   A study found that the standard deviation (a measure of volatility) of direct property investing over the period from 1985 to 2012 was close to 10%, compared to 20% for the stock market.  This data suggests that property investing is less volatile than investing in the stock market, however volatility is still present.

Leverage

One of the benefits of investing in property is the ability to borrow money to do so, which allows you to leverage you initial investment to purchase a more expensive property than you could afford without borrowing.  The downside of leverage is that it introduces additional risk.  If you invest $50,000 in the stock market, the most you can lose is $50,000.  If you use $50,000 as a down payment and borrow $400,000, then you get an asset worth $450,000, however you now owe $400,000 to the bank and are personally liable for making sure the money gets repaid.

Lack of diversification

Due to the large cost of purchasing property, it is difficult to create a diversified portfolio by investing directly.  If you own only one residential investment portfolio, you are heavily dependent on the performance of that geographic location, which means a very concentrated portfolio.  This issue can be overcome by investing via a fund, however then you do not have direct ownership or control over the asset, and are unable to benefit from negative gearing.

Management Costs

Investing in property comes with high management costs for the owner of the asset.  This includes agents fees, maintenance costs and other running costs (e.g. utilities, council rates, land tax).  These fees tend to result in much higher management costs for a property portfolio than a share portfolio.

What goes up must come down

There has been a lot of talk in the press about the Australian market being over-valued.  Whatever your view, it is worth remembering that market conditions change; house prices will eventually come down, and interest rates will eventually go up.  Here’s a good overview of the last housing crash, including interest rates of 17.5% – yikes!

The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs before acting on the advice.

What’s to love about property?

Property is one of the most loved asset classes in Australia, and the state of the property market is always in the press, whether it’s going up or down.

Property is one of the most loved asset classes in Australia, and the state of the property market is always in the press, whether it’s going up or down.

This week we look at the whys of investing in property.

Why invest in property?

Bricks and Mortar

Many people invest in property because they like the feeling of security that comes with having a tangible asset.  They also like the ability to see the asset for themselves.  It is a lot easier to conduct due diligence when you are purchasing an investment property, which you can visit and inspect, than it is to conduct due diligence on a company, where you are reliant on the information that the company provides, and your ability to ask the right questions to analyse the stock. 

Leverage

Most people borrow money to invest in property, meaning that they slowly build up ownership of an asset that they could never afford outright.  It is also possible to borrow to invest in shares, however property borrowing is less risky as you are generally not subject to  margin calls.

Income

Another benefit of investing in property is the income that it provides, in the form of rent.  Rental income is a common feature across all types of property investment, whether it be residential, office, warehouse or retail.

Capital Growth

In addition to rental income, property also offers capital growth, through appreciation of property prices.  Over the last 20 years, property has on average returned 10.5% p.a, this is the total return and includes both income and capital gains.

Tax Benefits

Certain kinds of property investing comes with tax benefits, namely negative gearing.  If you purchase a property for investment purposes, you are able to deduct the cost of managing the property and owning the property, including the interest on your mortgage.  This results in a reduced taxable income and can make property investing more affordable.

Next week we look at how you can invest in property, there are many more options that simply buying a house!

The information in this blog is of a general nature only and may contain advice that is not based on your personal objectives, financial situation or needs. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs before acting on the advice.

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