The value of asset allocation and portfolio diversification in tumultuous times

Over the last several weeks, shockwaves ripped through the financial markets sparked by “shelter in place” orders, business closings, and skyrocketing unemployment due to COVID-19. The Dow plummeted 8,500 points from March 4, 2020, to March 23, 2020, and bounced back nearly 4,000 points three days later—serving as a stark reminder that market timing is not a sustainable reinvestment strategy. Understandably, investors are concerned about their positions, and are rightfully re-examining their asset allocation model.

Traditional allocation models recommend a mix of fixed income and equities to fit risk tolerances and investment objectives (e.g., a model portfolio of 60% equities and 40% fixed income for moderate-risk investors). However, these models stem from a period in which alternative investments were largely unavailable to high net worth investors. With the advent of the internet and legislation promoting formation of private capital, including crowd funding and Rule 506(c) under Regulation D, investors now have unprecedented access to alternative investments. So what can individual investors adopt from allocation models previously only accessible to institutional investors?

University endowments are among the largest and most sophisticated investors, and consistently achieve high risk-adjusted returns by following a diversified asset allocation model that includes equities, fixed income and alternative investments, such as real estate, commodities, natural resources and hedge funds.

In the article “Investing Like the Harvard and Yale Endowment Funds,” Chart 3: Top Five Endowments Asset Allocation over time depicts the evolution of asset allocation by top endowment funds, where allocation to real estate and alternatives has increased 25%, increasing from 36% to 44% in the last two decades.

Given an individual investor’s relatively newfound access to alternative investments, they may want consider shifting towards a 50/30/20 equity/fixed income/real estate and alternatives model to achieve higher risk-adjusted returns. Furthermore, the recent massive market sell-off triggered significant capital gains for many investors that sold long-held positions with a low tax basis, so now is the time to reevaluate portfolio diversification, and not be tempted by timing the market to “ride it back up.” 

Rebalance with real estate

To cushion the blow of selling in a falling market and generating taxable gains, investors may be served well to consider a real estate investment located in an opportunity zone (OZ). This alternative investment can also provide broader asset allocation to diversify holdings and shield all future gains from taxation when disposed after the required holding period. Investors have 180 days to consider alternative investments in OZs and position themselves for the right real estate investment for their portfolio. 

For more information about diversifying your portfolio with an opportunity zone investment, or to learn how Baker Tilly Capital specialists can help, contact our team.

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