Volatility? Um, okay. What of it?

After all, yeah, sure, while it generates risk, it also can create opportunity, according to lazardassetmanagement.com. Meaning, rather than trying to circumvent it, fixed income investors should embrace it. Why exactly, you ponder? It’s because they could reap rewards from, like a scene straight out of the Wild West, looking it in the eye. No blinking, either.

In this atypical environment, the firm believes investors might want to abandon a passive mindset and chew over investments that leave “plain vanilla” bonds in the dust. Investors can come across fixed income solutions that have the potential to set up portfolios for the longer run by being creative and active. And don’t forget, mind you, diversifying globally.

Earlier in the year, etftrends.com reported that, potentially, fixed income classes could dispense better total return performance in 2023. That’s in the aftermath of a year riddled in negative returns that not only reset valuations – but to levels that seem more attractive. It’s especially so among investors with a more prolonged timeline.  

At Ares Wealth Management Solutions, we continue to receive inquiries from financial advisors regarding the forward prospects for private real estate given the recent decline in public real estate. We believe the most useful way to help advisors grapple with these questions is to point to historical data. Thankfully, we have data on both private and public real estate returns going back to March of 1978, and while no one can predict the markets, we believe the powerful benefits that private real estate can bring to a portfolio should persist through this cycle.

First, the basics—

Since 1978, public real estate has delivered approximately thirty percent higher annualized returns than private real estate. However, this can be largely attributed to public real estate using three times more leverage than private real estate, and as result, public real estate has experienced three times the volatility. Private real estate by comparison has provided much better risk-adjusted returns.1

Source: Bloomberg. All data from March 31, 1978, through September 30, 2022. Public real estate measured by the FTSE NAREIT All Equity real estate Index, which is a free-float adjusted, market capitalization-weighted index of publicly traded US real estate equity. Private real estate measured by the NFI-ODCE Value Weighted Index. The NFI-ODCE index is a capitalization- weighted, net of fees, time-weighted return index with an inception date of December 31, 1977 which represents various private real estate funds. Sharpe ratio is a measure of risk-adjusted returns and has been calculated using a risk-free rate of 2%.

Correlation

The low correlation of private real estate to public real estate, we believe, is particularly notable.The low correlation of private real estate to public real estate, we believe, is particularly notable.
Seeing the low 0.11 correlation figure, one of the natural questions that our financial advisor clients follow with is, "But is private real estate just public real estate on a lag?"To investigate whether the 0.11 correlation with public real estate is just a trick of lagged time, we run the correlation of private and public real estate after applying varying lag lengths.We find that the correlation ticks up mildly over time while remaining low. So, historically, any lagged effect of public real estate onto private real estate has been tempered.

Source: Bloomberg. All data from March 31, 1978, through September 30, 2022. Public real estate measured by the FTSE NAREIT All Equity real estate Index, which is a free-float adjusted, market capitalization-weighted index of publicly traded US real estate equity. Private real estate measured by the NFI-ODCE Value Weighted Index.

Drawdowns

During historical periods of drawdowns in public real estate since 1978, investors in private real estate had a noticeably different experience:

• Two-thirds of the time private real estate had no drawdown at all when public real estate was in drawdown.

• In the three occasions where private real estate did experience a drawdown, they came at a nine- to twelve- month lag on average.

• Over the past 40-plus years, private real estate drawdowns were meaningfully shallower and shorter-lived than public real estate drawdowns.

It turns out that private real estate has rarely followed public real estate into its frequent drawdowns—drawing down only three times since 1978 versus twenty-five times for public real estate over the same period. On those occasions when private real estate did draw down, it only moderately followed public real estate, and did so by a lag of nine months on average.It turns out that private real estate has rarely followed public real estate into its frequent drawdowns—drawing down only three times since 1978 versus twenty-five times for public real estate over the same period. On those occasions when private real estate did draw down, it only moderately followed public real estate, and did so by a lag of nine months on average.

In fact, historically, there have only ever been two meaningful (i.e., greater than two percent) private real estate drawdowns: one during the early 1990s recession following the Savings and Loan Crisis and the other during the Global Financial Crisis. These extreme real estate sell-offs were driven by over-building and over- leverage. These forces caused lending to dry up, at which point the private real estate market eventually capitulated (though less than the public real estate market).

History suggests that most public real estate sell-offs have been driven by macroeconomic worries and investor sentiment rather than by real estate fundamentals. This is supported by the fact that public real estate net asset values (NAVs) have tended to hold steady (like private real estate NAVs), even while the equity trades off due to market moves.2

Conclusion

As it turns out, conflicting public and private real estate returns, as seen in the present environment, have always been the normal situation, and it is not a matter of one being "right" and the other "wrong."As it turns out, conflicting public and private real estate returns, as seen in the present environment, have always been the normal situation, and it is not a matter of one being "right" and the other "wrong."At Ares Wealth Management Solutions, we believe both public and private real estate can play important, albeit very different, roles in individual investors' portfolios, and advisors should consider utilizing these tools to help achieve their clients’ overall financial objectives. That said, historical data indicates that these two investment asset classes should not be conflated, nor should public real estate be viewed as a leading indicator for private real estate.We find that historically only during the drawdowns of the Global Financial Crisis and the early 1990s real estate correction (resulting from recession and the Savings and Loan Crisis) did private real estate get deeply pulled into the malaise of public real estate. 

What each of those events had in common is that they followed a crisis in lending, leverage and over-building. We find none of these forces present in the current cycle.In 2022, private real estate was not pulled into the drawdown experienced by public real estate, nor was it during the steep drawdown of COVID-19 or the long (four-year) public real estate drawdown of the early 2000s when the Dotcom Bubble burst.3The question then for an investor to ask is: Looking forward, do you believe that the world is about to head into one of those over-built-and over-levered real estate sell-offs?At this time, we do not believe underweighting would be a prudent action. Because private real estate has historically delivered positive returns in nine of ten quarters, through many market cycles, we believe the investment thesis for a full, long-term (typically dollar- cost-averaged) allocation remains intact.3

DISCLAIMER

The material presented in this article is intended for informational purposes only. It does notThe material presented in this article is intended for informational purposes only. It does notconstitute investment advice or a recommendation to buy, sell or hold any security, investment strategy or market sector.Investing in shares of common stock of AREIT or AIREIT involves a high degree of risk, including the risk that payment of distributions is uncertain and cannot be guaranteed, the risk that an investment in AREIT and/or AIREIT is not liquid, and the risk that investors may lose the entire amount of their investment.AREIT and AIREIT may pay distributions from sources other than cash flow from operations, including without limitation from the sale of assets, borrowings, return of capital or offering proceeds, and advances or the deferral of fees and expense reimbursements, and AREIT and AIREIT may be required to fund their monthly distributions from a combination of their operations and financing activities, which include net proceeds of these offerings and borrowings (including borrowings secured by their assets), or to reduce the level of their monthly distributions. AREIT and AIREIT have not established caps on the amount of the distributions that may be paid from any of these sources.See AREIT Summary Risk Factors and prospectus and/or AIREIT Summary Risk Factors and prospectus for descriptions of other potential risks of investing in AREIT and/or AIREIT. Investors should carefully read and consider AREIT prospectus and/or AIREIT prospectus before investing. An investment in AREIT and/or AIREIT is not a direct investment in commercial real estate, but rather an investment in a real estate investment trust that owns commercial real estate.

FORWARD-LOOKING STATEMENTS

This communication includes certain statements that are intended to be deemed “forward- looking statements” within the meaning of, and to be covered by the safe harbor provisions contained in, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements are generally identifiable using the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” “project,” “continue,” or other similar words or terms. These statements are based on certain assumptions and analyses made in light of our experience and our perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate. Such statements are subject to a number of assumptions, risks and uncertainties that may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements. Among the factors that may cause results to vary are the negative impact of increased inflation, rising interest rates, COVID-19, and/or the conflict between Russia and Ukraine on our financial condition and results of operations being more significant than expected, general economic and business (particularly real estate and capital market) conditions being less favorable than expected, the business opportunities that may be presented to and pursued by us, changes in laws or regulations (including changes to laws governing the taxation of real estate investment trusts (“REITs”)), risk of acquisitions, availability and creditworthiness of prospective customers, availability of capital (debt and equity), interest rate fluctuations, competition, supply and demand for properties in current and any proposed market areas in which we invest, our customers’ ability and willingness to pay rent at current or increased levels, accounting principles, policies and guidelines applicable to REITs, environmental, regulatory and/or safety requirements, customer bankruptcies and defaults, the availability and cost of comprehensive insurance, including coverage for terrorist acts, and other factors, many of which are beyond our control. For a further discussion of these factors and other risk factors that could lead to actual results materially different from those described in the forward-looking statements, see “Risk Factors” under Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2021, and subsequent periodic and current reports filed with the SEC. In addition:• Interest rates for long-term U.S. treasuries have risen sharply in 2022, after declining for approximately 30 years; if interest rates for long-term U.S. treasuries stay elevated or continue to rise, real estate prices and returns may not perform as well as they did in the prior period of declining interest rates;• It is possible that private real estate prices will suffer a drawdown similar to that of public real estate in 2022; if private real estate prices suffer such a drawdown, new investors in AREIT or AIREIT may be subject to substantial

In 2022, Commonwealth Financial Network onboarded 270 new advisors, comprising a total of $11.2 billion in total client assets. The majority of the company’s advisors are fee-based, while the company is privately owned. The company also offers broker-deal and insurance products. 

In a statement, Wayne Bloom, CEO of Commonwealth said, “Despite the difficult headwinds our advisors, their clients, and the industry faced last year, our team was extremely successful in bringing top-caliber financial advisors to our firm.” As Bloom looks forward, he is targeting $1 trillion in total assets under management, while maintaining the values that have enabled the company to succeed. 

The company added that the new advisors came from a variety of backgrounds including RIAs, independent brokers, regional practices, and wirehouses. The company is also looking to continue targeting ensembles and larger firms. It’s especially interested in targeting those with an entrepreneurial bent, offering them services like a Virtual Transition Support team and an expanded offering of Outsourced Business Solutions. 

Finsum: In 2022, Commonwealth Financial Network had a record-breaking year with 270 new advisors onboarded. 

In an article for Vettafi, James Comois laid out some ways that direct indexing can help reduce taxes. Direct indexing essentially lets investors create their own customized indexes that are appropriate for their personal situations and can help them reach their financial goals. 

Rather than buying an ETF or a mutual fund, investors buy the holdings directly. The obvious advantage is that it leads to more personalization so that portfolios can reflect an investors’ values and/or accommodate a unique situation.

A secondary benefit is that it can lead to a lower tax bill, so it may have additional utility for investors to offset capital gains. In essence, losing positions can be sold and then rebalanced into equities with similar factors.

Some of the likely factors that make it more likely that direct indexing can be useful are a high federal or state tax bracket, large investment pool, a steady replenishment of assets, volatile markets, and short-term capital gains. In contrast, the benefits of direct indexing are not substantial enough to offset the additional complications.

Finsum: Direct indexing can be a better choice for certain investors who need greater customization and have high tax bills.

For bond traders, 2023 has been one of the most volatile years in recent decades. It’s not entirely surprising given the various forces impacting the market such as inflation, a hawkish Fed, a slowing economy, and significant strains to the banking system.

In a Bloomberg article, Michael Mackenzie and Liz McMormick discussed reasons why these conditions will persist for the remainder of the year. In response, investors are looking to remain nimble and flexible especially given wide swings and a risky environment. 

Bond traders are expecting this uncertainty to continue as long as the Fed continues its hiking cycle and gets clear when it will start cutting rates. A major factor in Treasury inflows has been the slowing economy as recession fears increase, however the labor market continues to add jobs, and the economy continues to expand. Additionally, the recent spate of bank failures and financial stress also was supportive of Treasury inflows. 

Maybe the best illustration of the volatility is the 2-Year Treasury yield which got as high as 5.1%, following Fed Chair Powell’s hawkish comments. And. it got as low as 3.6% a few days later amid the failure of Silicon Valley Bank.

Finsum: The bond market has experienced incredible volatility in Q1. However, odds are that this volatility will continue all year.