Guest post written by Eelis Vatanen @thewealthyfinn.com
It has been an exceptional time to be an investor for the past ten years. With a wide enough diversification, anybody would have got gains on the stock market just by being in them. With such a long bull market behind us and volatility on the rise many are naturally asking: “how long it will last?”
It seems that the most popular form of investing nowadays are index ETFs and they sure are great. Taking into account that an average investor consistently loses to the index, ETFs should be the smart choice for everyone, right?
There are a few things that gives me pause in a heavy index-ETF portfolio though: the exposure to small caps is non-existent.
Small caps historically perform well
It’s no news that measured by annualized returns, small caps tend to over-perform large caps. This always comes with added volatility though, and thus risk. Nevertheless, small caps should not be overlooked when investing for high returns.
A number of news articles hit the internet in August 2019 when Michael Burry - the same person who made boatloads by predicting the housing bubble over a decade ago - said he sees a bubble in passive investing.
When bonds don’t virtually have any interest, capital has flown into stock markets. ETFs are becoming ever more popular and predicted to surpass active management in the U.S. by 2021. Capital finds publicly traded stocks through ETFs, but especially micro cap companies are less accessible for investors and thus the demand is significantly lower.
This creates good opportunities, like we see on Envestio.
Crowdlending has created a new market
Before crowdlending platforms, how could anyone invest in small companies that weren’t publicly traded? You had to apply for one from a bank or an investment company.
Now, companies such as Envestio have created a completely new market for private investors to invest in small, unlisted companies. This is great for both parties: First, it creates more supply for these companies which leads to lower interest rates for them and second, the interest rates are high enough for private investors to find interesting.
Since the stock market is showing signs of increased volatility and valuations have climbed due to recent high supply of capital, simply being all-in in index ETFs doesn’t sound like the only long-term move you can make.
Especially when high-yield loans are available in the unlisted micro cap segment.
Smart money is diversified
While ETFs are efficient diversification tools, they neglect smaller companies. Diversification should also be done over multiple asset classes, not just stocks.
Modern Portfolio theory states that you can optimize your risk-to-return ratio by building your portfolio from assets that do not correlate strongly with each other. With bonds, volatility comes from the borrower not being able to pay back the debt. This is tackled by Envestio’s buyback guarantee.
When high-yield corporate bonds are added to a portfolio of stocks, the overall volatility of the portfolio can be reduced, without reducing returns. For me, this is the strongest argument for diversifying into crowdlending instruments such as Envestio - it makes sense from a scientific perspective.
Investing with Envestio is straightforward, but due to the success of the platform, projects get funded very quickly. As it isn’t a completely obvious decision I’ve written more about the pros and cons of this in my Envestio review, but an investor should consider using the auto investing feature for best diversification.