Asset Allocation and Government Policy – Musings

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  • Real estate has become unsexy with millennials while equities, gold and lately cryptocurrencies have become popular.
  • The last decade has seen a fundamental change in consumer preferences towards renting versus owning their primary home. The virtues of buy and hold stock investing have been extolled by every expert and followed like the gospel by young investors. This worked fine during the 11-year economic expansion but made household balance sheets extremely fragile. With the income shock caused by Covid-19, the chickens are coming home to roost.
  • I believe that household balance sheets and consequentially national economies would be much more resilient if more people owned houses. For this governments need to find policy solutions to increase housing supply, discourage home ownership for solely investment purposes, and actively help young people to buy a home.

Covid-19 has brought back volatility to markets and forced everyone to look hard at their portfolios. One of the most interesting and passionate debates nowadays is around the massive printing of money by central banks around the world. 

Bearish views like these and recent market events forced me to think about my asset allocation strategy and question nearly everything I have seen in my ~6 years of watching markets. For context, I come from a world view where a) renting is better than buying, and b) the only asset worth owning other than cash is equities.

Recap of the last couple of months in financial markets:

The question then is how to position your personal portfolio for these crazy times and the massive uncertainty ahead of us. The idea for my personal portfolio health check was:

  • Not endeavour to make any extreme predictions (if you were to hold one asset and one asset only for the next 10 years, what would it be?) 
  • Evaluate each asset class relative to each other and how they actually performed versus my expectations
  • Improve asset allocation going forward based on both financial and emotional/behavioural criteria

The results surprised me. From being a steady rent instead of buy guy, my gut now tells me real estate has the best risk/reward for me long term. To clarify I am talking about owning a primary home and not an investment property. Acting on this impulse is a distant goal, but the mindset change is good enough for now. 

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I quickly rejected the two safe haven assets Fin Twit is now so bullish on: gold and crypto. If everyone believes gold is the contrarian bet of the century, is it really a contra bet?

The other prominent contra bet is BTC, but I don’t understand it (and I suspect the vast majority of longs don’t either).

Why real estate?

It is scarce, has real utility, can generate income, permits large allocations, and is emotionally neutral or rewarding. The emotional/ behavioural factor is perhaps the most important and something I only appreciated because of the market crash. 

The Old Vicarage, Wetton

What about the other options?

  1. Cash: There has never been a better and worse time to hold cash. If you were in cash before the market tanked, you feel like a genius. However, cash earns close to nothing (less than nothing in some countries) and given the returns in other assets over the last decade, taking a cash call requires either extreme risk aversion or the ability to perfectly time markets, neither of which I possess. As an Indian even cash in the bank is not entirely stress-free and you need to know your bank’s balance sheet and also pray you can withdraw your money when you need it 🙂
  2. Equities: Currently the only asset class I hold, split roughly 50:50 between direct stocks and mutual funds. The market crash was sobering to say the least. Stocks were unpredictable on the way down (blue chips getting slaughtered the same as junk) and many have inexplicably bounced back as well. Based on public information, most famous bulls did not buy into the crash meaningfully so either they think this time is different or they are hypocrites. Businesses everywhere have proven to be extremely fragile and generally a disappointment to investors – frozen CEOs, no risk management, no capital buffers, earnings and dividend histories suddenly meaningless etc. The universe of companies that inspired confidence was already thin and has become even thinner now. Stocks are also emotionally draining in good AND bad times – an extremely underrated factor which you can only understand through experience.
  3. Bonds: I can’t see how bonds make any sense for a young person. You either take on credit risk without the upside of equity or buy safe paper and live with extremely low or negative real yields.
  4. Gold: Gold has no utility for me. If the Dollar really fails, I don’t see people transacting in physical gold. It earns no income. It’s difficult and expensive to store. Jewellery is okay but as an investment at the portfolio level, I don’t understand it. Prices are currently at highs, but I guess valuations matter less for gold. The current crisis has shown that gold can be unreliable, and people queue up to sell when everything else is falling.  I assume a large allocation in gold can only be done through a financial instrument – in other words buying paper gold. Doesn’t this defeat the purpose of gold as a safe haven?
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Net-net I’ve used the sell-off to rebalance my equity portfolio towards higher quality stocks. The mid to long term goal is to have at least a 50% allocation to real estate with the rest split between equities (probably only via mutual funds) and cash.

Thinking about safe havens and asset allocation led to some thinking around the nature and causes of the recession (depression?) we are facing. And it brings me back to real estate.

Unfortunately, nobody my age talks about buying or building a home: renting is the default. And why not? Housing prices globally have been absurdly inflated by the wealthy and supply artificially constrained.

The price of an average house in Mumbai is 74 times an average Indian’s monthly income – at a generous 40% savings rate that’s 15 years of diligent savings to buy a house! The global stock of real estate is valued at over US$ 220 trillion – more than 12 times the GDP of the US or 18 times the GDP of China. Consequently, the have-nots have forgotten about home ownership and take solace in Buffetisms, Mungerisms and the “fail-safe” power of compounding stocks.

Data shows that the U.S. renter population grew twice as fast as the owner population during the last decade. 

Homeownership in general has been on the decline for at least the last three generations. After adjusting for age, millennials, gen Xers, and baby boomers have all purchased homes at a slower rate than the generation that preceded them.

This generation of renters did fine through the longest economic expansion in history. 

What happens now with an equally unprecedented income shock? 

A full 20% of Americans and counting have applied for unemployment benefits in the last few weeks. How is that possible if the economy was the “strongest ever” until February?

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We live in times where massive amounts of consumption can happen online and at home. Goods can be delivered. Services on video or at home. White collar jobs are uninterrupted.

Yet there are massive recessions underway globally – why?

I strongly believe that a big part of this on the consumer end (the C in the C+I+G+X-M GDP formula) relates to housing. Household balance sheets are just too fragile. Even those without debt are sitting on a bunch of paper assets and we all know what happens to correlations during crises.

With millennials spending 30%-60% of their incomes on rent, any real or expected income shock will lead renters to cut back on spending viciously to protect their rent payments. And this austerity will not go away in a hurry.

Consider this recent story about a Brooklyn landlord waiving millions in rent. The guy owns 18 buildings and has 300 tenants in New York City. The Times ran a feature on him for his generosity and considers him a hero. 

Victor J. Blue for The New York Times

I couldn’t help wondering: what if these renters were homeowners instead?

300 strong balance sheets instead of 1.

This is not a critique of other asset classes per se, but I think household balance sheets and consequentially national economies would be much more resilient if more people owned houses. For this governments need to find policy solutions to increase housing supply, discourage home ownership for solely investment purposes, and actively help young people to buy a home. Fundamentally this is about the long term redistribution of wealth and should be considered in addition to existing policy interventions like one-time handoutsuniversal basic income or taxing the super-rich.

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Currently building a dating app | Previously: Investments @ Asia Climate Partners | MSc. Finance from HKUST
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