Diversification Works When Done Correctly

At Alitis, we spend a lot of time reading and learning about the financial markets. We stay up-to-date on current events, we constantly monitor our positions, and we are always keeping an eye out for new investments that could improve our portfolios and their diversification.

That being said, we do understand that the financial marketplace can be a complex and confusing place, and there are some common pitfalls that we need to be mindful of. One of those pitfalls is called naive diversification.

Naive Diversification

Naive diversification occurs when someone has bought many different investments that they incorrectly believe to have the benefits of having either a low or negative correlation. They hope that they are protected from having large losses across their portfolio at the same time, but unfortunately, they are not.

An example would be someone that has “diversified” their portfolio by buying all the bank stocks in Canada. This is better than putting all of one’s money into only one bank stock, but there are plenty of factors that would affect all Canadian bank stocks at the same time. The same could be true of a portfolio containing all stocks in the world, as stock markets globally have similar exposures and are highly connected.

Imagine having a closet full of different shoes, but they are all high heels. You have hundreds of pairs of high heels, full of colourful designs, patterns and fabrics, but only high heels. If we asked you, “Do you have many pairs of shoes?” your reply would be, “Of course! I have hundreds of pairs!”

We would think that you must be well-prepared for all occasions with so many shoes. However, the next time you go to buy groceries after it snows, or you go to mow the lawn, or you go on vacation to Europe and have to walk down a cobblestone street, you may be surprisingly ill-equipped.

Our Approach to Diversification

At Alitis, we take a great deal of time and effort to ensure that your portfolios are both well-dressed and well-suited for a variety of market conditions. We select investments with purpose and keep in mind how new investments will complement the rest of the portfolio. After all, how your entire portfolio performs is more important to us than any single investment.

We look to create meaningful diversification across many asset classes and markets with the goal of providing a stronger risk-adjusted return than our benchmarks. And we are proud of that.

Real Estate Investments in Victoria

Real estate has been a core asset of the world’s wealthiest families and largest institutions since the beginning of time. Real estate houses the world’s businesses and provides shelter for the broader population. The appeal of real estate is based on the characteristics of the investment returns. There are three main sources of return from real estate: net rental income, debt reduction (as the mortgage is paid down), and growth in value as rental income and property values increase over time. Real estate tends to be a very stable asset class that delivers reliable rental income and tax-efficient long-term growth.

In 2018, average rents in the Victoria Census Metropolitan Area (CMA) increased 7.5% while the purpose-built rental apartment vacancy rates edged up to 1.2% from 0.7% in 2017 as the supply of rental units (construction completions) outpaced the increase in the demand for rental units. According to the 2016 Census and the 2011 National Household Survey, between 2011 and 2016, Victoria CMA added 9,340 households and of these household four of every five chose to rent instead of buy. A combination of stable employment prospects among younger age groups (who tend to be renters), the persistent gap between the cost of homeownership and renting, and population growth is expected to generate sustained demand for rental housing, resulting in below average long-term vacancy rates. Market demand, low financial costs in the current interest rate environment and favorable development policies for purpose-built rentals are supporting the construction of an expanded and updated rental stock in the Victoria CMA. (Source: “Housing Marketing Information.” Rental Market Report: Victoria CMA, Canada Mortgage and Housing Corporation, Fall 2018.) For these reasons, Alitis views the Greater Victoria area as a stable market.

Alitis is actively investing in the local market through partnerships with experienced developers and has projects that are in different stages of development including pre-construction (zoning or permitting), under construction, and buildings that are now completed and income producing.

Here are our current investments in the Victoria area:

The Enclave

The Enclave - Langford, BC

Developer: Ironclad Developments | Location: Langford, BC | Type: 81 Unit Apartment Development | Completed: February 2018 Held in the Alitis Income & Growth Pool, Alitis Growth Pool & Alitis Private REIT

Meaford Heights

Developer: Ironclad Developments | Location: Langford, BC | Type: 106 Unit Apartment Development | Completed: March 2019 | Held in the Alitis Income & Growth Pool, Alitis Growth Pool, Alitis Private REIT & Alitis Private Real Estate Limited Partnership

Belmont Landing

Developer: Stride Properties | Location: Colwood, BC | Type: 48 Unit Apartment Development | Estimated Completion: July 2020 | Held in the Alitis Income & Growth Pool, Alitis Growth Pool & Alitis Private REIT  & Alitis Real Estate Limited Partnership

Hedstrom House

Developer: Ironclad Developments| Location: Langford, BC | Type: 119 Unit Apartment Development | Estimated Completion: June 2020 | Held in the Alitis Income & Growth Pool

To learn more, please contact info@alitis.ca or call 250-386-4933.

Recent Returns in the Markets

As you have likely seen in the financial news, the equity markets experienced a sharp pullback starting in late September. The largest market in the world, the US stock market, dropped by almost 10% from its recent peak on September 20th to its recent low on October 29th. Market corrections have historically been a blip and recoveries have always eventually occurred. In the current case, markets are already showing signs of a recovery, with the US market up over 6.5% from its recent low as shown in the table below.

Recent Returns in the Markets

Market Index Asset Class Returns
Sep 20 to Oct 29 Oct 29 to Nov 7
FTSE TMX Canada Universe Bond Index (C$)1 Canadian Bonds +0.15% -0.64%
FTSE World Broad Investment Grade (US$)2 World Bonds -1.24% -0.13%
S&P/TSX Capped Composite Index (C$)3 Canadian Stocks -8.91% +4.46%
S&P 500 Index (US$)1 US Stocks -9.76% +6.57%
MSCI World Index (US$)4 World Stocks -9.84% +5.54%

Sources: 1. Blackrock, 2. FTSE Yieldbook, 3. TMX, 4. MSCI

Nobody likes to see drops of the magnitude we saw after September 20th, but this type of market environment is the reason Alitis started our business and our funds. Markets rise and fall and the volatility of the markets brings risk, but our mission is to manage volatility and deliver solid, longer-term returns while providing a more stable ride in achieving them. These types of conditions, and the slower-moving ones we have seen over the last few years, allow Alitis to fulfill this mandate. As well, it also showcases why the enhanced diversification of the Alitis approach benefits you.

The most obvious observation from the table above is that bonds did quite well during this downturn. World bonds actually made money in Canadian dollar terms as that index is quoted in US dollars and the Canadian dollar dropped during the downturn. From an investment perspective, we have underweighted bonds for some time simply because they have not offered much upside return. However, they almost always have a place in a portfolio as they will usually make a little money when stock markets experience the jitters. And this is exactly what happened here; they did their job perfectly and acted as a counterbalance to stocks.

That is not to say that bonds are your only option for diversification! At Alitis, we use many other asset classes and strategies to provide further diversification and to provide greater growth potential. Below is the approximate asset allocation of all the Alitis Investments, which illustrates the much broader diversification that we use when managing your investments:

Approximate Asset Allocation of the Alitis Investments

Fund Cash Bonds Mortgages Stocks Real Estate Other Alternatives
Alitis Strategic Income Pool 5% 46% 19% 4% 2% 24%
Alitis Income & Growth Pool 1% 25% 15% 31% 18% 10%
Alitis Growth Pool 0% 0% 7% 49% 37% 7%
Alitis Mortgage Plus Fund 0% 0% 86% 0% 0% 14%
Alitis Private REIT 11% 0% 0% 0% 89% 0%
Alitis Private Real Estate LP 1% 0% 0% 0% 99% 0%

Allocation information as of October 26, 2018

What the table shows is that stock and bond markets had essentially no impact on the Alitis Mortgage Plus Fund, the Alitis Private REIT, and the Alitis Private Real Estate LP as their investments were primarily exposed to other markets and types of investments. As for our three diversified investments, Alitis Strategic Income Pool, Alitis Income & Growth Pool, and Alitis Growth Pool, stocks and bonds make up less than half the assets. As such, the ups and downs of these markets will likely have less than half the impact on each of these investments, which is about what was experienced.

We have underweighted stocks and bonds in the Alitis Investments for quite a few years now as it was our view that these asset classes were overvalued. However, overvaluation can continue for quite a long time so not investing in an asset class can also lead to problems. This is why we usually under-weight asset classes rather than eliminating them entirely.  In the case of bonds, the market peaked a few years ago and this asset class has generated no return for over two years. Our decision to underweight bonds and increase exposure to mortgages and other alternatives has been well-rewarded. On the other hand, stocks continued to rise over the last few years so our move to real estate and other alternatives, while still very profitable, has not been as well-rewarded.

So what does all this mean for you and your investment portfolio?  Well, a few things come to mind:

  1. Being broadly diversified across traditional asset classes (stocks & bonds) and alternative asset classes (mortgages, real estate, others) provides you with a portfolio which performs more consistently across a broader range of market and economic conditions.
  2. Alitis’ underweighting to the stock markets means that your portfolio will not be impacted as much by what goes on in the that market.
  3. When any asset class drops in value, it becomes more attractive, not less so, and that should get you excited for the possibility of capitalizing on those events.

There has been a drop in the stock market and a bit of a bounce-back, but these market corrections are considered short-term fluctuations that in the long run, help your portfolio. It is often said that the markets are governed by two emotions – greed and fear. People tend to get greedy after markets have risen because they see everyone else making money and people tend to get fearful after losses that look like they will never end. The profitable thing to do is the opposite – be fearful when markets keep rising and money looks easy to make, and be greedy when markets drop and other investors are in despair. And as always, DIVERSIFY! This is what Alitis does and why we continue to anticipate making solid returns with less risk.