Risky mortgage bonds triggering the next crash?
+ how you can ‘protect’ yourself from market volatility caused by a single Tweet
|Investment Superhero||Nov 8, 2019|| 6|
Happy Friday to all of you, and welcome to our issue #14! Hope you’ve had a financially prosperous week. In this week’s edition of the Gist, we’ll discuss the impact of risky mortgage bonds on the overall market, how you can ‘protect’ yourself from market volatility caused by a single Tweet, and why some investors are hyped about real estate crowdfunding.
As a reminder, the Gist comes to your Inbox once a week and is not meant to be financial advice or a recommendation to purchase any product or security. If any of this is useful to you, please invite your family and friends to join the community here.
You can also ask us any finance or investment question privately by visiting AskFinny.com. We will share the most insightful questions and answers with our Gist audience.
So here are the questions for today’s edition:
I’ve heard there is a new class of risky mortgage bonds, similar to subprime loans from 2008, that are popular with some investors. Will that cause the next crash of the US market?
The stock market is at a record-high level, but a Tweet away from a crash. How do I protect myself from this insane level of volatility?
What’s real estate crowdfunding and why are people hyped about it?
Let’s give you the summary first.
The risky mortgage bonds—and loans granted to borrowers who are ineligible for conventional mortgages—are popular again. Some investors are biting—coupons on those bonds can be north of 5% and the assets under management have grown 44% this year alone. We think this won’t cause the next crash though. The risky mortgage bond market is way too small ($18B) for now to cause broader disruptions that subprime bonds did.
To state what you probably already know: diversification is a tried-and-true portfolio management approach that addresses market volatility. While many investors may simply prefer to wait out market volatility, especially the type of volatility caused by a single Tweet, some active investors are using more tactical approaches—reducing exposure to riskier positions via minimum volatility (min vol) ETFs. Some popular min vol ETFs (measured by net assets) are: USMV, SPLV, and EFAV.
Crowdfunding is the use of small capital amounts from a large number of individuals to finance a new business venture. Crowdfund real estate offers a higher potential annual return ranging from 6% to 12%. Keep in mind the S&P 500 historical return is approximately 7%. However, your crowdfunded investment is illiquid—the cash you invest cannot be withdrawn penalty-free for at least 3 years with most platforms—and your returns are taxed as ordinary income. Below is the return profile of the real estate crowdfunding platform Fundrise.
The subprime mortgage-backed bond triggered the global 2008 financial crisis, but a security with some of the same high-risk characteristics, non-qualified mortgage (non-QM), is taking off.
This is a loan granted to borrowers who are ineligible for conventional mortgages. In 2019, lenders have bundled more than $18 billion worth of these loans into bonds sold to investors. This is a 44% increase from 2018 and the most for any year since the securities became common post-crisis.
Initial delinquency rates on non-QM loans appear to be really high: 3% to 5% for some bonds. That’s multiples of the current 0.7% delinquency rate on Fannie Mae loans.
But overall consensus is that non-QM bonds won’t cause the next market crash (at least, not for now), because the amount of assets tied to those bonds is still way too small.
Min vol ETFs can be used to lower overall portfolio risk. For instance, if your portfolio consists largely of cyclical stocks, a min vol ETF might dilute some risk exposure in the event that the market becomes volatile.
If you are concerned about a US stock market decline, you may want to consider researching min vol ETFs, the largest of which (by net assets) are:
iShares Edge MSCI Min Vol USA ETF (USMV); represents the MSCI US minimum volatility index;
Invesco S&P 500 Low Volatility ETF (SPLV); represents the S&P 500 minimum volatility index;
iShares Edge MSCI Min Vol EAFE ETF (EFAV); represents MSCI’s developed markets (excluding the US) minimum volatility index.
Here is a side-by-side comparison of those ETFs.
How you leverage real estate crowdfunding depends on whether you are an accredited investor or a non-accredited investor. Non-accredited investors have an annual income less than $200,000 (or $300,000 for joint taxpayers) or less than $1 million in liquid assets. If this is you, you can only invest in crowdfunded REITs. This means you don't get to pick individual projects. It's more like buying an ETF that holds a basket of investment properties. One of the best platforms to start real estate crowdfunding is Fundrise, which requires only a $500 initial investment.
Accredited investors can invest in crowdfunded REITs or individual properties. However, individual properties usually require higher initial investments of at least $5,000. Some platforms that cater to accredited investors include PeerStreet, RealtyMogul, and DiversyFund.
Unlike public real estate whose investment performance correlates with the broad stock market, crowdfund real estate doesn't have a fluctuating share price. You will earn income from loan interest payments and monthly rent income. And you will earn equity income when the crowdfund platform sells their position in a property for a profit.
That’s it for this edition. What would you like to hear about in the next Gist? Ask us a question here.
The AskFinny Team