Low Correlated Asset Classes
Can Low Correlated Asset Classes Continue?
I was talking about investment with Zhen. One of his concerns was about the historically low-correlated asset classes are now becoming more correlated over time. The correlation between the US equity markets with the international markets is increasing. Even for the emerging countries, the correlation is increasing. He was worrying about the low-correlation asset classes may no longer exist in the future.
I addressed this question with two examples. One is the equity/bond pair. Another is the Equity/REIT pair. Their historically low correlation coefficients are still working. The basic reasons are due to their structural differences between these pairs.
Between corporate equity and corporate bonds pair, there are two forces are working consistently. One force is the equity/bond issuing corporations. The corporations have two choices to raise capital. One is to issue equity stocks. Another is to issue bonds. The corporation has a goal to minimize its cost of capital. When bonds are cheap, they will issue bonds. If equity is cheap, they will issue equity.
Another force is that there are two classes of investors. The growth-seeking and risk-taking investors are interested in stocks. The income-seeking and risk-averse investors are interested in equity. Since the two classes of investors have consistent behaviors over a long time. So the low correlation coefficients will continue to exist for a long time.
For the equity/REIT pair, this difference is even bigger. REIT is a real estate investment trust. Real estate investment is generally a local-event. In the North-Dallas area, there is a fast-growth area between North-Plano and South-Frisco around the area near Dallas-North Parkway and State Highway-121. There are several major investors in the area. One is Ross Perot, who was the head of EDS; own a big piece of land in the area. Another is the General Growth Properties, the largest mall REIT in the country. Between them, they own a big portion of land in the area. So the land price has increased several folds over the last decade.
For equity companies, most of their worth is in intangible assets such as brand names, operational procedures, intellectual properties. Physical properties are not the main holdings for them. They are looking for efficiency over the global scale. The may design products in the United States, manufacture them in China, distribute them in Europe. These companies are globally focused.
The difference between equity/Reit is structurally determined. Additionally, the legal structure is also different. REIT companies do not pay corporate taxes while most equity companies have to pay corporate taxes and investors has to pay taxes on dividends as well. So equity investors in general have to pay double taxes while REIT owners do not pay double taxes.
I was talking about investment with Zhen. One of his concerns was about the historically low-correlated asset classes are now becoming more correlated over time. The correlation between the US equity markets with the international markets is increasing. Even for the emerging countries, the correlation is increasing. He was worrying about the low-correlation asset classes may no longer exist in the future.
I addressed this question with two examples. One is the equity/bond pair. Another is the Equity/REIT pair. Their historically low correlation coefficients are still working. The basic reasons are due to their structural differences between these pairs.
Between corporate equity and corporate bonds pair, there are two forces are working consistently. One force is the equity/bond issuing corporations. The corporations have two choices to raise capital. One is to issue equity stocks. Another is to issue bonds. The corporation has a goal to minimize its cost of capital. When bonds are cheap, they will issue bonds. If equity is cheap, they will issue equity.
Another force is that there are two classes of investors. The growth-seeking and risk-taking investors are interested in stocks. The income-seeking and risk-averse investors are interested in equity. Since the two classes of investors have consistent behaviors over a long time. So the low correlation coefficients will continue to exist for a long time.
For the equity/REIT pair, this difference is even bigger. REIT is a real estate investment trust. Real estate investment is generally a local-event. In the North-Dallas area, there is a fast-growth area between North-Plano and South-Frisco around the area near Dallas-North Parkway and State Highway-121. There are several major investors in the area. One is Ross Perot, who was the head of EDS; own a big piece of land in the area. Another is the General Growth Properties, the largest mall REIT in the country. Between them, they own a big portion of land in the area. So the land price has increased several folds over the last decade.
For equity companies, most of their worth is in intangible assets such as brand names, operational procedures, intellectual properties. Physical properties are not the main holdings for them. They are looking for efficiency over the global scale. The may design products in the United States, manufacture them in China, distribute them in Europe. These companies are globally focused.
The difference between equity/Reit is structurally determined. Additionally, the legal structure is also different. REIT companies do not pay corporate taxes while most equity companies have to pay corporate taxes and investors has to pay taxes on dividends as well. So equity investors in general have to pay double taxes while REIT owners do not pay double taxes.
posted by Unknown at 8:48 PM
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