The Perils of Sitting on the Sideline

3 Minute Read

Stuck at a crossroad between election uncertainty and pandemic-related concerns, many investors are pulling off the road to sit things out. But waiting on the sideline has drawbacks. The market rarely provides an all-clear signal to invest, and when it does, the best opportunities have usually passed.

We believe investors would be better served driving ahead strategically with their investment plans than trying to pinpoint re-entry into an asset class or strategy. In this blog, we look at some of the perils of sitting on the sideline, particularly for yield-seeking investors who may struggle to find much needed income.

For those sitting on the fence pondering their investment strategy, we offer the following:

•      You can’t wait until tomorrow if you need income today. Sitting on the sideline is most troublesome for income-seeking investors. Whether a foundation or pension needing to fund monthly payouts or an individual seeking retirement income, every month or quarter that assets sit in cash chips away at their future.

•     The outlook for interest rates isn’t changing. In August, the Federal Reserve announced a major policy shift, saying it will adopt a more flexible inflation targeting strategy. Translation: The Fed will allow rates to stay lower for longer, even if inflation runs above 2% for periods. Therefore, investors will need to identify alternative income sources , but they must be careful in their search. In a low-yield environment, some investment strategies will employ excessive leverage to manufacture yield, which could prove risky. Taking excessive credit risk in a stretch for yield is also a precarious proposition in the middle of an economic downturn. For those seeking new sources of durable income, real estate investments could be an attractive alternative. Real estate investments are underpinned by hard assets, providing a level of transparency unavailable in many opaque, alternative fixed income structures. Moreover, contractual obligations with tenants support the cash flows of real estate, making the asset class less volatile than many fixed income options.

•    Opportunistic windows close quickly. A common refrain we hear from investors is that they want to keep “dry powder” available for tactical moves. We appreciate the desire to be opportunistic. At Forum, our commercial real estate debt approach is poised to take advantage when market conditions create specialized opportunities while maintaining a disciplined, long-term focus. History shows that opportunistic windows close quickly. This was particularly true in the recent downturn. Within equity markets, the S&P 500 went from bear market territory to notching new record highs in just 126 trading days, the fastest recovery on record. Within debt markets, the opportunistic buying period only lasted about three months, according to our own experts. If investors want to take advantage of fleeting, opportunistic buying periods, they should allocate to dynamic investment funds and strategies ahead of time. That means making decisions today, not when a volatility event occurs.

•    Tax rules could change. Given a rising deficit, it’s likely taxes will increase. Investors seeking strategies or asset classes with favorable tax treatment may benefit from investing today, getting “grandfathered” into tax advantages before they change.

•    Finally, the track record for investors timing re-entry points has been poor. A host of behavioral finance studies and academic work show that investors have a poor record of market timing, often getting out of markets too late, then waiting too long to re-enter. This article from Institutional Investor shares findings from famous studies to show how much an investor’s actual return can lag a fund or portfolio’s achieved return because the investor pulled out or piled in at the wrong time. Some of the studies show that investors lose as much as 1% to 2% in annual returns from attempted market timing.

"For those investors waiting to be opportunistic, we would argue that the window for attractive entry points is slim, and that they should allocate to dynamic investment strategies now so that capital is in place to take advantage of a special situation. If fear is holding you back, a better strategy might be to invest in an asset class or fund that protects against the market event you are concerned about."

Don't Wait, Act

We don’t deny that there is plenty of uncertainty that could affect markets. Elections and news about the pandemic and economy could all provide sources of volatility. But we don’t recommend investors sit on the sideline waiting to see what happens. We believe laddering into investments is the right course of action, rather than sitting on the sidelines.

For those investors waiting to be opportunistic, we would argue that the window for attractive entry points is slim, and that they should allocate to dynamic investment strategies now so that capital is in place to take advantage of a special situation. If fear is holding you back, a better strategy might be to invest in an asset class or fund that protects against the market event you are concerned about.

Finally, for income investors, traditional options for yield are unlikely to get more appealing any time soon. These investors would be better off identifying alternative sources of income today before more principal erodes.

We believe commercial real estate debt could be one of the most viable alternatives. The asset class has a low correlation to traditional bond markets, and continues to offer relatively high yields, even in today’s low-rate environment. Given income prospects elsewhere, it may be worth getting off the sidelines to explore what the asset class has to offer.

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Forum Investment Group is a private real estate investment firm with expertise and emphasis on generating current income and long-term value creation by accessing unique real estate acquisition, development and debt investment opportunities across the capital stack and real estate cycles. Since 2007 we’ve invested more than $2 billion in real estate and built a successful track record of high-performance investments, earning the trust of our investors and partners.

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Nick Thompson – Senior Managing Director – Forum Capital Advisors
nthompson@forumcapadvisors.com