RealTMOR Asset Mgmt LLC and RealTMOR Apartment Mgmt LLP
It is imperative for HNIs to be invested in multiple assets and in important countries. UHNIs with large holdings (net-worth of $10mm+ to $30mm+), in many cases, have such ownership. This stems from their multi-country business interests and international stock, bond and real estate holdings. The HNIs in the category of $1-$10mm, referred to as HNIs for this write-up, need to follow this asset allocation strategy albeit differently. Unlike UHNIs, they may not have multi-country business exposure or financial advisors providing global market exposure or reliable local stakeholders providing access to multi-country real estate.
EFFECTS OF CURRENCY RISK SHOULDN’T BE UNDERSTATED EVEN IN COUNTRIES WITH GREAT ECONOMIC DYNAMICS:
Most HNIs do tend to lead a “global” lifestyle and hence currency risk is a real issue. Even countries with great GDP growth and surging equity markets, like India, have experienced severe currency devaluation. The Indian economy and equity markets (NIFTY) have grown 6.5% +/-/year and 175%+ (including dividends) during the last decade but its currency has depreciated 30%. Economies, like China, where the currency gyrations are controlled or pegged to USD, have experienced lower equity market returns. Shanghai’s and Hang Seng’s 10 year equity returns are under 25% and around 65%+ respectively (including dividends).
VOLATILITY OF EQUITY MARKETS ARE SIGNIFICANT EVEN IN “DEVELOPED, STABLE ECONOMIES”:
As a long-term investment, the US equity markets are the world’s best “equity” markets. Their benefits don’t need to be individually elaborated. The S&P 500 (including dividends) returned 150%+ and the NASDAQ returned 275%+ over the last decade (average pricing for 2008). Higher returns are compensation for assuming higher risk (volatility). Compared to US residential real estate, annual long-term volatility of the S&P 500 is 15%+/- while that of real estate is 2.5%. In the similar 10-year time frame, national US residential real estate has returned approximately 75% (including rental income). The risk assumed in US equity markets is around 6.0x higher than the risk assumed in US national residential real estate while returns are just above 2.0x. Over the 18 year period, from 2000-2018, this difference is even more stark. The total returns for the S&P 500 were 130%+/- and the annual volatility was 15% while those for US National Real Estate were 140% and 7% respectively. This illustrates that exposure to both sets of assets is critical to balance risk and return of an HNI portfolio. The volatility (risks) in emerging market equities (even the high flyers) like India or Hong Kong is significantly higher. Additional to country specific risks, local companies, even larger ones, have higher corporate governance issues, legal/regulatory concerns and other risks. For instance, Indian pharmaceutical companies (generics producers) have a “true” global cost/expertise advantage. However, over the last 3-5 years, global regulatory bodies (FDA) have flagged significant issues. This has resulted in stock price losses and higher risks.
TIMING OF ASSET PURCHASES IS SELDOM PERFECT:
The scenarios listed above assume favorable dynamics for investors, includes buying assets when the global financial crisis (2008) unfolded. “Buying opportunities” across multiple assets and countries sprang up. The subsequent Central Bank intervention created a “historic” bull market which some argue still exists. One of the truths of asset management is that “timing markets” is difficult-to-impossible. Consider unfavorable scenarios, like purchasing S&P 500 index in H2 2007 or NASDAQ in 2000 which would result in negative returns for 5-13 years respectively. Miami residential properties bought in 1999 or 2000, provided a total return (capital gains and rents) of under 75% till 2011-2012 (12+ years). Include debt costs, vacancies and other adverse features into the mix and the returns deteriorate to under 50% over this prolonged period. If purchased in 2003, capital gains would be close to 9% till 2013-2014 (10 years). In Las Vegas, real estate purchases around 1999-2000 would have provided capital losses till 2012 (12+ years) and total returns under 50%. Even in major regional centers like Mumbai (having prized real estate), purchases around 2013 produced zero to negative returns till the end of 2018 (5 years). Indian real estate gains have out-sized reliance on capital appreciation because residential assets provide negligible rental yields. Such returns are painful in the Indian context where risk-free rates (Government of India debt) yields 6.5% (tax free) and annual inflation is 5%+/-. Leverage will create further problems for investors during tough times (foreclosures/short sales would not allow the property owner to “weather the storm”).
DIVERSIFICATION OF ASSETS TO CREATE “EFFICIENT/STABLE” HOLDINGS IS NEVER A PRIMARY FOCUS:
Often HNIs concentrate towards assets “perceived” to be best known or best performing. Most HNIs DO NOT hold balanced assets across geographies/industries etc. There are advantages to that strategy (sector-knowledge) but risk-related advantages of diversification are missed. In emerging markets, there are aren’t enough “high-quality” companies providing adequate risk management. Even in the fast-growing ASEAN countries (Thailand or Philippines), the stock market is not deep or liquid and the economy is not diversified enough. In resource-driven markets, like Malaysia, Brazil, Gulf countries, this problem is more acute. Most large companies would be either natural resource or construction or consumer companies. Even developed countries (UK, Germany, France or Australia) have equity markets which tend to have significant concentration of certain sectors. The US is one economy that has well-diversified, well-regulated, diverse and deep equity markets. But in the US, because of the size of the market, it’s tough to be “well diversified” and there could be reliance on ETFs/MFs, which have their own issues (costs associated with MFs or dependence on “calls/judgment” of managers).
Many non-US HNIs minimize debt or equity holdings due to the above reasons. Many Asian and European (except Germany) HNIs tend to be concentrated in real estate. US HNIs have equity holdings through retirement accounts but could have out-sized and levered real estate holdings (“McMansion Syndrome”). But, biggest problem in this mix, many people (including HNIs) feel real estate holdings need to be LOCAL. Thus real estate holdings tend to get concentrated close to residential locations and in home country. I believe, this is the biggest mistake that most individual investors make in terms of real estate purchases. Real estate holders in Texas or the Midwest did not have gains during the last US bull cycle but subsequently did not experience pain when the “bubble burst”. Many coastal investors lost much money once the US bubble burst.
MAIN SOURCE OF WEALTH OR INCOME CONCENTRATION COMPOUNDS PROBLEMS:
Many HNIs have high profile jobs or businesses that are connected to their home country and maybe its main/ancillary industry. So, when times are bad it could reflect in their primary source of wealth. If this pain is also reflected in their “other assets/income source” the pain points and downward spiral are magnified. British HNIs or French HNIs that have large concentration in their home markets will have heightened concerns due to Brexit or Euro-growth slowdown related issues. Japanese HNIs with large East-Asian exposure would suffer adversely in case of a US-China Trade war after suffering through the “lost-decades” and the “deflationary cycle”.
ALL THESE PROBLEMS ARE COMPUNDED FOR INVESTORS IN “NON-MAJOR” MARKETS:
These issues are compounded for HNIs connected to resource rich markets such as Gulf countries, Malaysia, Brazil or economies with growth/other concerns such as Russia, South Africa, most Latin American countries. These HNIs could experience significant wealth destruction due to significant devaluation of the currency/economic turmoil (Russian Ruble lost 50%+/Brazilian Real lost 40%+/- in a short time). Oil price fall and glut in the fossil fuel market has affected the economies of Gulf countries and is visible in Dubai real estate prices. Smaller economies like South Africa and African/Latin American countries have political issues causing wealth destruction.
There are many issues and problems but these major issues which should give HNIs pause. HNIs should absolutely own assets across multiple sectors, “economically important” countries and asset classes. Geographic diversification would have helped US real estate investors when the US bubble burst because real estate in Asia boomed then. Similarly, for Asian investors having exposure to rising US real estate from 2013 would alleviate some pain currently experienced in their currency and real estate. Also, owning a combination of equity and real estate is key because equities recover faster than real estate after a downturn. It’s not a question of should an HNI own equity or real estate or own domestic or foreign assets? The question should be: “what is the optimum way to be invested across all these different dimensions with the amounts available to HNIs”?