Bonds haven’t protected you from the bear market in stocks. But this one asset class could have

Would you be interested in an asset class that produces long-term returns that are nearly as good as the stock market but is as uncorrelated with the stock market as bonds are?

Of course you would. But does such an asset class exist?

Yes, and it’s right under our noses — literally: Residential real estate.

This is especially valuable information now that stocks have entered into a bear market and bonds have failed to provide the cushion that investors had hoped. On June 13, the day the S&P 500
SPX,
+0.22%

closed more than 20% below its Jan. 3 high, long-term Treasurys were sitting on an even bigger loss — 22.1%, as judged by the Vanguard Long-Term Treasury ETF
VGLT,
+0.32%
.

Residential real estate, in contrast, not only resisted stocks’ decline but actually gained in value. We don’t know the precise magnitude of the gain, since house prices aren’t quoted on a daily basis. But the S&P Case-Shiller 10-City Composite Index rose 8.9% from Jan. 3 to June 13, according to FactSet. The spot futures contract that is pegged to this index advanced 9.8% over the same period.

This happy result is not a fluke.

Consider the findings of a major research project into what its authors refer to as “The Rate of Return on Everything.” The database, which extends back to the late 1800s, was compiled by Òscar Jordà of the Federal Reserve Bank of San Francisco; Katharina Knoll of the Free University of Berlin; Dmitry Kuvshinov of the Universitat Pompeu Fabra; Moritz Schularick of the University of Bonn; and Alan M. Taylor of the University of California, Davis.

They found that in those calendar years since 1891 in which the U.S. stock market fell, U.S. residential real estate produced an average gain of 6.4%. That’s nearly two annualized percentage points better than the comparable return of long-term U.S. government bonds, according to the researchers. Furthermore, residential real estate did even better than bonds in years in which the stock market rose, beating long-term U.S. government bonds by 4.7 annualized percentage points.

A result of this “heads-I-win-tails-I-win-even-more” history means that residential real estate has hugely outperformed both stocks and bonds on a risk-adjusted basis. Its Sharpe Ratio — a measure of risk-adjusted performance — was 76% better than for U.S. stocks and 82% better than for U.S. government bonds.

Inflation and real estate

Another characteristic of residential real estate that makes it especially valuable as a portfolio diversifier is its performance during inflationary times. The table below segregates all years since 1891 into four equal groups according to their rates of inflation. Notice that this asset class’ average total return increases with inflation, unlike what is the case for either stocks or bonds.

Inflation quartile

U.S. stocks’ total return

U.S. long-term government bonds’ total return

U.S. residential real estate’s total return

25% of years with lowest inflation

13.4%

3.4%

5.0%

Second-to-lowest inflation quartile

14.3%

4.1%

9.1%

Second-to-highest inflation quartile

10.4%

8.3%

9.4%

25% of years with highest inflation

6.2%

3.6%

12.0%

Too good to be true? It’s only natural to wonder if there’s a catch.

And there is: There is no way easy way to invest in residential real estate as an asset class. About the only way is to do so is with one of the futures contracts on the CME that are benchmarked to the Case-Shiller index. (Please note that investing in commercial real estate via a fund is entirely different than investing in residential real estate.)

But this is an imperfect solution, since the market for these contracts is thin and the longest-maturity contract is just five years out. That means that every five years, you face the risk of rolling a maturing contract into a subsequent one at possibly unfavorable prices.

The only alternative to investing in a Case-Shiller futures contract would appear to be your home or other individual residential properties. That also is an imperfect solution, since you inevitably will incur lots of idiosyncratic risk with those investments. You could end up hugely outperforming the asset class as a whole — or seriously lagging it.

Still, as the “Rate of Return on Everything” researchers note, residential real estate’s performance is so impressive that it remains a compelling part of a diversified portfolio even after accounting for factors such as rollover risk in the futures market and idiosyncratic risk with individual properties.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected].

Source: https://www.marketwatch.com/story/bonds-havent-protected-you-from-the-bear-market-in-stocks-but-this-one-asset-class-could-have-11655479881?siteid=yhoof2&yptr=yahoo