Friday, January 25, 2019

Should you buy REITs based on a "Good" Sponsor ? Part 2

Here's a nasty thought experiment.

Suppose on one hand, you have a team that is a sample of RI, ACS and Hwa Chong students. Their average PSLE score is 265.  We shall call this team A.

Team B consists of a bunch of kids from government secondary schools, such Changkat Changi Secondary or St Gabriel secondary secondary  etc... Suppose this selected sample would also have an average PSLE score of 265 ( this is a small sample size and some kids volunteer to go to ordinary schools ! )

Is there a significance in the life outcomes of these different group of students ?

This experiment was done on the outcomes of SAT candidates who enter different universities in the US and it was found that, generally speaking, the SAT score is a better predictor of wealth and success in life than the quality and brand name of the school itself.

Now suppose Singaporeans get to bid to buy a share of the earnings of this sample of students in the future. I think, given how kiasu we are, the RI boys will command a much higher price.

But because you will be paying less to get the cash flow from Team B, you should expect the folks who bet on Team B to make more money moving forward.

The last time we had a discussion about the debunking the "Good Sponsor" theory, we had a pretty good debate because I understand why some fairly experienced REITs investors got upset over my article.

Today I'm going to share with you a different experiment that basically came  up with the same conclusion.

Another well known anomaly in US is that stocks with a lower average volume tend to outperform. This can happen for many reasons. Perhaps low volume stocks present an illiquidity premium. It is also possible that low volume counters receive lower analyst attention so it may be amenable to some bargain hunting.

For the baseline, equal weighting REITs for 10 years ending on 31 December 2018 would result in returns of 18.45% with a semivariance 10.36%. Do note that I've been promoting an equally-weighted all-REIT portfolio for quite a while in my previews.

So once again, I decided to conduct an experiment, this time using the factor of average volume of the REIT over the past 6 months.

Here is a snap-shot of the ten REITs with the highest 6-month average volume as of two days ago.

So once again, we are looking at the more popular REITs in the stock market. With the exception of Lippo, any sponsor of these REITs can be subjectively agreed to be "good sponsors". I say this because I'm still not getting a firmly agreed stance as to what is a "good sponsor".

What about the ten REITs with the lowest average volume ? Well it looks like this :

The reputation of this list of REITs is not definitely as stellar as the previous screen-dump.

If you have been buying the REITs with the highest 6-month average volume for 10 years right up till 31 December 2018, you would have done well : 19.24% returns with a semi-variance of 11.55%. The problem is that you are getting higher returns for a higher downside risk.

Here's the magical finding.

If you have bought instead the REITs with the lowest 6-month average volume, you would return 20.28% with a semi-variance of 9.95%. The REITs with the lowest volumes produced a better return at a lower risk.

Here's my proposed conclusion and you are free to argue a different interpretation of these results.

Choosing a REIT with a lower average volume is a superior investment strategy to choosing a REIT with a higher average volume. To exploit this advantage, you have to do the opposite of what many investment experts and value investors say : you have to avoid or to reduce your exposure to REITs with "good sponsors". This is because these good sponsor manage their REITs so well that retirees and non-experts plough their money into these counters in the hopes of getting safe yields, many of these guys just want 6% yields.

The collective retail investor fund flows into these better run REITs counters makes it harder to derive extraordinary profit from them.


  1. Thanks for sharing. Interesting results

  2. It would be better if your backtest included a severe recessionary period / bear market. 😉

  3. Hi Chris,

    In summary, REITS with good sponsors have positive expectations which are priced in. As they are expected to do well, there might not be room for surprises and no market mispricing to take advantage of

    REITS with "second tier" sponsors is expected to not do as good. And when they perform beyond expectations, there might be significant price appreciation.

    It will be good to extend your back test to periods of market stress to see which REITS can survive. Adding leverage to leveraged investment vehicles means that everything must perform perfectly as expected and there is little room for error.

  4. Yes, I agree that the backtest needs to cover a recessionary period. In the next round of tests, I will stretch the test before the Great Recession.

    A fairly good counter argument I saw so far is the question of whether anyone would feel comfortable holding on to Team B REITs when the economy turns south.