2013 rewarded most equity investors. Backed by broad market strength, the Dow, S+P 500 and NASDAQ each neared record highs. Several economic indicators are fueling optimism in 2014, as well.
Low interest rates are keeping borrowing costs down, allowing cheap access to capital for companies to expand. A weak U.S. Dollar allows American products to price competitively in overseas markets, which adds revenue sources for domestic companies. Non-traditional financing is also thriving, as venture capitalists are funding innovation.
Despite the rosy outlook, equity rallies can cause us to lose perspective and chase performance. Investors may overlook portfolio imbalances that increase their investment risk. Certain sectors, asset classes or market caps may have ballooned to no longer reflect your time horizon and risk tolerance. Technology companies in particular tend to dominate many portfolios.
So, how can you proactively manage risk yet stay bullish?
Adding doses of negative correlation is a convenient solution. Investments that tend to move separately from the broader market help us create portfolios for dynamic conditions.
Here are some ideas to consider. These investments also have merit beyond negative correlation:
Real Estate Investment Trusts (REITs):
The liquidity, credit and time needed to invest in real estate are beyond many smaller investors. REITs are an affordable and liquid alternative to owning property. Unlike owning real estate, you can easily buy and sell publicly traded REIT shares. Investors may easily take and unload positions based on changing markets or needs. The IRS requires that REITS pay out 90% of taxable income to shareholders.
Several REITs currently have yields over or near 6%, with some international options offering double digit payouts. Real estate is a volatile asset class that often moves separately from equity markets. Investors should consider REITs as a small portion of their portfolio, rather than a core investment.
To reduce volatility, you could consider hybrid REITs. Hybrids act as landlords and mortgage lenders. By collecting rent payments and also earning mortgage interest, these REITs are poised to benefit from different real estate trends.
REIT Strategies: Using REITs, you can also capitalize on demographic trends, such as the healthcare overhaul and aging population. Investors may buy healthcare REITs that specialize in senior care centers or hospital properties. REITs that invest in geographic regions with booming property development are another example of this concept.
Exchange traded funds (ETFs) or mutual funds are suitable for most REIT investors. International REITs open up overseas property markets to smaller investors. Much like foreign bonds, dividends from global REITs may be increased in dollar terms. Your currency adjusted total returns could also be higher with a weak dollar.
Income investors faced low yields across issuers in 2013. With risk free treasury yields at rock bottom levels, corporate bonds can affordably compensate investors for added risk. Investors should also have perspective on how interest rate changes may affect their portfolio.
Bond maturities of 3 to 10 years offer an attractive hedge for several reasons. These bonds add negative correlation by moving differently from the broader market. Intermediate maturities are also appealing when there is interest rate uncertainty.
It is unlikely that short term Fed rates will head any lower. Similarly, when and if rates will rise is also uncertain. Intermediate bonds offer attractive yield spreads to shorter maturities, with less interest rate risk than long term debt, which are battered by rate hikes.
Do you know how your portfolio would respond when interest rates change?
Mutual funds are an easy way hold intermediate bonds. The credit quality and interest rate sensitivity of bond funds can be seen through Bloomberg or Morningstar.
Intermediate Bond Strategies: Based on your income needs and risk tolerance, overseas bond funds may be an option. For passive income seekers, interest payments from stronger foreign currencies are enhanced when converting to weaker dollars. Foreign bond exposure may be a choice for higher risk tolerances.
Summary- Periodic Portfolio Review
Bull markets often add subtle risks to your portfolio. You can gain insight for changing market conditions with periodic portfolio rebalancing.