- "Great salsa is all about diversification" - Dr. Craig L. Israelsen.
- When you examine the non-SWANs, you can see why SALSA is truly the spice of life.
- My Small Cap REIT Portfolio has returned over 21% YTD.
- By employing diversification correctly, investors can reduce risk without sacrificing returns; our Durable Income Portfolio is a perfect example of that!
I just finished content for the December edition of the Forbes Real Estate Investor (newsletter), and I am excited to release the year-to-date performance results. Specifically, my core portfolio - the Durable Income Portfolio - has returned 11.9%.
A majority of the REITs held in my Durable Income Portfolio are sleep-well-at-night (aka SWAN) REITs that have demonstrated a successful record of risk management. Some of the best-performing SWANs include names like Digital Realty (DLR) +23% YTD, W.P. Carey (WPC) +27% YTD, and STAG Industrial (STAG) +25.7% YTD.
However, there’s a reason that I don’t exclude REITs that aren’t SWANs… As Dr. Craig L. Israelsen explains:
“Great salsa is all about diversification. Only by adding diverse ingredients together can we achieve the desired outcome. However, there are some ingredients in salsa that most of us would never want to eat individually, like hot peppers or Tabasco sauce. But, without the “hot” ingredients the salsa would be flat.”
That’s exactly right, if I had excluded the non-SWANs within the Durable Income Portfolio, the performance would have been just 1.5% (equal weight). As Israelsen explains, “each investment asset adds an important dimension to the portfolio because each asset behaves differently. This diversity is vitally important in salsa … and in portfolios.”
When you examine these non-SWANs below, you can see why SALSA is truly the spice of life (Note: My Small Cap REIT Portfolio has returned over 21% YTD).
Similar to construct a REIT portfolio, investment portfolios should include a wide variety of diverse ingredients or “assets.” Israelsen adds:
“Mutual funds that invest in US stocks are a core ingredient for a portfolio, analogous to tomatoes in salsa. But, US stocks are only one asset class. More asset classes are needed. We need non-US stock. But, even after adding non-US stock, our portfolio still only has “stock” ingredients. We need diversifying ingredients such as bonds, real estate and commodities.”
Way back when, there were two dominant investment categories (or asset classes), namely US stock and US bonds. These two assets became the mainstay ingredients in balanced mutual funds, with the typical ratio being a 60% allocation to large US stocks and a 40% allocation to bonds. Israelsenexplains:
“News flash, it’s not 1959 anymore.”
He explains that “a multi-asset balanced portfolio brings a higher standard to the notion of “balanced.” This new age balanced portfolio is known as the “7Twelve® Portfolio”. The name makes reference to “7” core asset classes with “Twelve” underlying mutual funds.
The 7Twelve Portfolio is constructed to generally follow the time-tested 60/40 guideline, but uses eight funds (instead of one) to create an overall equity exposure of about 65% and 4 fixed income funds (instead of one) to create a “bond” exposure of about 35%.
All 12 ingredients are equally weighted (each representing 8.33% of the 7Twelve Balanced Portfolio). The equal-weighting is maintained by periodic rebalancing (annual rebalancing is recommended).
The fundamental (or core) concept behind the 7Twelve portfolio has been tested over a 47-year period from 1970 to 2016 using 7 of the 12 sub-assets: Large US Equity, Small US Equity, Non-US Equity, Bonds, Cash, REITs, and Commodities (These 7 sub-assets have performance histories back to 1970, whereas not all of the components in the 7Twelve do). Each sub-asset was equally weighted in the portfolio (14.3%) and annually rebalanced at the start of each year. Taxes and inflation were not taken into account.
As you see in the above chart, REITs have historically delivered competitive total returns, based on high, steady dividend income and long-term capital appreciation. Their comparatively low correlation with other assets also makes them an excellent portfolio diversifier that can help reduce overall portfolio risk and increase returns. These are the characteristics of real estate investment.