September 27, 2023


A Home Grown Success

Storm only just beginning in the real estate investment market

Martin Pelletier: Investors should watch these three areas with caution and consider some alternatives for each

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A portfolio manager’s job is to always flush out risks and factor them into the investment decision-making process, though year-end is naturally a time to look back and ahead.

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Looking at things from a risk-per-unit-of-return basis has served us very well in markets such as the current one. With that in mind, here are three areas you may want to keep a very close eye on along with what we think are some much better alternatives.

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Private real estate equity and debt markets

We think the storm is only just beginning in the real estate market and it could wreak havoc once this year’s rate hikes fully kick in and people wake up to the reality that we may not be going back to pre-2022 levels.

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For example, Toronto housing market sales in November collapsed by 49 per cent from a year ago, and yet the composite benchmark price was only down 5.5 per cent during the same time frame.

From an investment standpoint, there are some sizable cracks finally starting to appear in the sector that could easily turn into the biggest risk in 2023.

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For example, Romspen Investment Corp. recently announced it will “temporarily defer payment” of redemptions from its $2.8-billion Romspen Mortgage Investment Fund. Starlight Group Property Holdings Inc., which owns $25-billion worth of apartment buildings and multifamily properties in Canada and the United States, just announced it is halting monthly payouts from two funds.

And, even more notable, Blackstone Inc.’s US$69-billion real estate fund started limiting withdrawals last week. We read that the fund was somehow able to post a net 9.3-per-cent return over the first three quarters of the year while publicly traded real estate investment trusts (REITs) dropped 20 to 30 per cent in value. It isn’t a surprise that investors would cash in at a gain while comparable public market investments are down considerably.

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There is a lesson in here for investors: if the net asset value of your fund has not moved, hit the sell button before the gates go up.

If you want to stay invested in the sector, look at public REITs that are marked to market and trading at huge discounts to last year. You can also replace your exposure with structured notes, which in many cases have yields exceeding what you were earning in private real estate or private mortgages, but with liquidity and downside protection.

Technology stocks

One of the most interesting trades we’ve been following is the Nasdaq versus 20-plus-year Treasuries — via the Invesco QQQ Trust Series 1 and iShares 20 Plus Year Treasury Bond exchange-traded funds — as they’ve been moving in unison all year. Both are down approximately 29 per cent over the past 12 months.

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We’ve noticed that many investors don’t seem to realize technology equities have duration exposure (sensitivity to interest rates) given the timing of their companies’ cash flows as well as dependence on ultra-low rates and cost of capital to fuel their growth.

For those looking to position around a reversal of interest rates or a so-called U.S. Federal Reserve pivot, we wonder if long-term bonds are the safer trade between the two, because they will outperform should there be an economic recession while tech stocks will sell off.

For now, we’ve been avoiding both, but have only just begun dipping our toes in the longer-duration bond market.

EAFE emerging markets

We have a zero-weight exposure to emerging markets such as China, since we just don’t see the path to recovery given the continual starting and stopping of its economy because of COVID-19 lockdowns.

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We also have minimal exposure to Europe, Australasia and the Middle East (EAFE) given their poor energy policy, more so in Europe, which has been taken advantage of by Russia, thereby putting significant pressure on their economies.

There are also the currency risks in these regions against the U.S. dollar, which continues to gain in value as the European Central Bank and Bank of Japan are unable to keep pace with the Fed.

We think resource-based markets such as Canada are the better alternative here due to their exposure to energy and materials. We also like the value segments of the U.S. market including health care, financials, energy and utilities.

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There is always the caveat that the risks mentioned above get dealt with, but we wonder just how much is really factored into valuations.

At least segments such as technology, REITS and even EAFE stocks are marked to market and are already considerably down this year compared to many private real estate and private mortgage funds that are not. This doesn’t mean these funds have a low correlation to public markets, but perhaps they have a heck of a lot more downside risk ahead.

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.


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