The reason why investing is so hard is because markets are relentlessly chaotic and we really have no means to predict the shelf life of a good investment strategy.
The journey of an investor involves eating a lot of humble pie and reversing some of the cherished ideas you picked up at earlier points of your journey.
We are not alone in this.
On 15 December 2018, I went to a Bloomberg terminal with a specific purpose – to debunk the popular idea that REITs with the best sponsors may not provide the best returns to investors because the REITs with top sponsors already have a strong reputation and may be overbought.
The intellectual challenge I had to overcome was to figure out which factors were suitable as a proxy for manager quality. This was a good idea – employing Market Capitalization also allowed me to test for the “small firms effect” suggested by academics where they claimed that small firms outperform large firms because they were riskier so have to provide a larger risk premium to retail investors. So I settled for using market capitalization after observing the screen.
Ten of the largest REITs last year looked like students who have been selected to attend the Gifted program :
Ten of the smallest REITs, in contrast, looked like students found in detention class :
Backtesting last year, I discovered that indeed, the ten REITs with the smallest market capitalization not only did better return wise, but the returns also came at a lower risk. This resulted in the following slide which I normally share with my students in every batch.
Fast forward one year later, when I conducted the class in September 2019, I noticed an interesting blip – picking the REITs with the smallest market capitalization is starting to lose it’s magic to such an extent that I have to revise the findings made last year.
In short, it’s time to eat my words and consider the possibility of a reversal.
So this time around, I started backtesting a REIT strategy that selected a REIT specifically for how large it is.
The results show a complete reversal of my earlier finding :
The 5-year and 10-year return of a REIT portfolio both had superior returns compared to the baseline strategy that bought every REIT in equal weights, albeit at a higher downside risk.
There are several possible ways to explain this phenomenon :
- For the past year, investors have piled into the bigger names as REIT buyers began to search for more stability. This was a period of “flight to quality”.
- Retail investors do not really care about lower dividends. When there is a looming trade war, they want higher-quality buildings with better tenants.
- Investors are beginning to discover a new form of trade involving index inclusion. REITs that are introduced into the FTSE NAREIT REIT or the STI index tend to experience an upswing.
There are practical consequences for ignoring this flight to quality.
When the course was conducted last month, my students were offered Mapletree Commercial Trust by the quantitative model and chose to reject it because they argued that there was little upside to the counter. Yields had been compressed to less than 4%. As I have a personal preference for high yielding stocks, I happily agreed with the class.
As it turned out Mapletree Commercial Trust went from $2.14 to $2.24 because it has been selected to replace HPH Trust in the Straits Times Index.
My students would have done so much better had they listened to the quantitative model and not discarded this stock.
Your investment journey is going to be full of similar mistakes when reviewing your portfolio on hindsight, but you can take comfort that missing out on a good investment will not be fatal to your investment results. Net-net, students of the Early Retirement Masterclass have made a larger number of better decisions then bad ones.
While it is too early to conclude how well my students have done since last month over the longer term, the portfolio built by them currently has an internal rate of return of 27.08%, not too shabby if you ask me.
Eating humble pie often and happily.
It’s where the money lies.
Ps; I speak often about early retirement and the choices facing us today. In my talks, I also provide some free strategies moving forward for passive income, and, for reaching retirement goals earlier using the stock market. You can find out more here. If you want to, book a seat here directly if this interests you.
- Juris Doctor(Cum Laude)
- Bachelor in Engineering from NUS (1st Class Honours)
- Masters in Applied Finance also from NUS.
- CAIA, FRM qualifications and passed all three CFA examinations.
I have recently completed my Juris Doctor and have been called to the Singapore Bar. For the past 15 years I was an IT manager and I have worked in multinationals, financial exchanges, trade unions and even a government agency. I started my career as an AS/400 administrator and moved on to manage IT projects and operations.