Volatility in Stocks and Property

Diversifying assets in a portfolio to mitigate the effects of market volatility is a commonly known practice. If you want to hedge against volatile equity markets, property can be a good alternative. 

The stock market offers several advantages, like high liquidity and easy access, which you can’t find in property. But on the other hand, it’s a property market that offers benefits like lower volatility than the stock market and less correlation with public market investment performance.

Thanks to these differences real estate investments are complementary to investment portfolios allocated largely to stocks or bonds, as they provide meaningful diversification.

Volatility and correlation are the key measurements which illustrate the advantages and disadvantages of each market type. 

Correlation shows the degree to which investment performances are related to one another. Investments can have positive, negative or no correlation with each other. You should remember that your portfolio is more diversified if you hold investments with little or no correlation.

Volatility is a way to calculate risk over time. When volatility is appropriately spread, a portfolio has a lower risk of loss in the event of poor performance from a given company, sector, market etc.

Volatility and correlation exist in every investment, but their amounts vary by different features like investment type, and market.

Public and Private Markets – Correlations and Other Values 

Markets can be categorised in many ways, but the most fundamental distinction is between private and public markets, where the main differences are the buying/selling dynamics.

Public Market Characteristics 

The main characteristics of the public market are:

– high efficiency, thanks to prices set by the market

– transparency of transaction details (public information about an investment)

– low transaction costs (low costs of the transaction), which facilitate high-volume trading

Thanks to these attributes, investments can be sold and bought quickly, so the public market offers high liquidity.

However, these attributes bring higher volatility too. Especially efficiency, which enables high trade volume. And, when the volatility is combined with a correlation of investment, the stabilisation and diversification of a portfolio are diminished.

Investors may not even realise how correlated their stocks are. Sometimes, companies from totally different industries share the same risk because of relying on the same fundamental inputs as oil. An increase in oil prices may cause a loss of profit in furniture and grocery companies because of increased transportation costs. And if you own investments in both, the negative risk is doubled in this scenario.

So, despite the upsides of the public market, a portfolio composed of public traded investments only is possibly more correlated than you may realise.

Stocks are usually very volatile during highly inflationary periods. At the beginning of this month (May 2021) increase in inflation rates have caused a drop in European stocks prices and Wall Street’s main indexes, led by tech-related stocks.

Private Market 

The private market operates differently than the public market, and thanks to this, they have the power to make a complementary, diversified portfolio. 

Private Market Characteristics

The main characteristics of the private market are:

– inefficiency

– higher transaction costs

– fewer buyers and sellers than on the public market

– information not public, not shared across parties

– prices are negotiated

Because of these characteristics, it can seem unprofitable at first glance, but the private market has less correlation and volatility than the stock market. It also allows investors to earn above-market returns in a way that is impossible in an efficient market.

Private market investments are traded at a lower frequency, which results in fewer changes to their real values. Daily changes are generally minor and less frequent than in the public market, meaning investors in property don’t tend to check on their investments on a daily basis.

Private market property has a lower trade volume, so it is less liquid than stocks, but it helps to prevent volatility in the values.

Property is a unique hard asset too. It can earn income while hedging inflation because they are naturally limited. At the same time, a rise in inflation would possibly cause a rise in the prices of many asset classes.

In the private markets, buyers and sellers can negotiate the prices of an asset, so investors can get above-market returns. This is possible because of a limited number of sellers and buyers.

Why should you care about low correlation and volatility?

Investments with low correlation help you to reduce the risk of the portfolio.

If you have uncorrelated assets in your portfolio you don’t have to worry if one of them unperformed, because the strong performance of the other will mitigate the risk.

If you want to diversify beyond an all-stock growth allocation, investing in property could help with that balance. Some people don’t want to do this, as individual investment property requires both lots of capital and hands-on participation.

Nowadays, you can invest in property without owning it, by investing with P2P platforms, like Sourced Capital. It is a good way of diversifying a portfolio and decreasing investment volatility. What’s more, your funds are much more liquid while you are investing in P2P than when you’re holding a property.

If you want to learn more about investing in hands-off property without purchasing it, please contact our Investment Team on email investorteam@sourced.co or tel. 0333 900 9999