Jeremy Chia, Author at The Good Investors : Page 19 of 20

A Simple Framework for Picking Low-Risk Stocks

Risk management is an essential component of investing. We can try to reduce the risk of permanent loss by investing in low-risk stocks.

Risk management is essential when building a stock portfolio. But it is impossible to remove risk completely. Instead, we should find ways to reduce risk in our investment portfolio, while maintaining a good chance for high returns.

With that in mind, here is a simple framework for picking low-risk stocks.

How to find low-risk businesses?

A low-risk business should have a strong balance sheet and an ability to consistently generate cash. Ideally, I look for companies with six qualities that should indicate it has a resilient business.

1. A manageable debt load and low-interest expenses

The company should be able to easily service its interest expense and to pay back its debts when they’re due. The company should have both a high-interest coverage ratio (how easily it can pay back its interest expenses using profits or free cash flow) and a low debt-to-equity ratio.

2. Consistent free cash flow generation

Cash is the lifeblood of a company. It is what the company needs to pay its creditors and suppliers. A company that is able to generate cash after paying off all its expenses and capital requirements (free cash flow to equity) is then able to reward shareholders through dividends, share buybacks, or reinvesting in the business.

3. Predictable and recurring sales

In order to generate cash consistently, a company needs recurring sales. A low-risk business should have recurring and fairly predictable revenue. This can come in the form of repetitive customer behaviour or long-term contracts.

4. Low customer concentration

The business should also have a varied pool of customers. A high customer concentration might cause wild fluctuations in sales and profits.

5. A diversified business

Similarly, the business should ideally not rely on a single revenue source. A business that has multiple revenue streams is more resistant to technological changes disrupting a single core focus.

6. A long track record

Finally, a low-risk business should have a reasonably long track record of all the above qualities. The track record should ideally span years, if not, decades. Businesses that have such an admirable track record demonstrate resilience and management’s adaptability to technological disruptions.

How to find stocks that will not suffer from valuation compression?

Besides investing in stocks that have resilient businesses, we should also consider the risk of valuation-compression.

A valuation compression occurs when a company’s market value declines permanently despite sustained earnings growth. This happens usually because the starting valuation is too high. If the purchase price is too steep, a good business may still end up becoming a bad investment.

The most common metrics that are used to value a stock are the earnings, cash flow, and book value.

Another metric that I like to use is the enterprise value to EBITDA (earnings before interest, tax, depreciation, and amortisation). The metric is also known conveniently as EV-to-EBITDA.

The enterprise value, or EV, strips out the company’s net cash from its market cap. Companies whose cash make up a large proportion of their market caps are prime acquisition targets. In addition, the net cash balance could also act as a support for which the company’s market cap will likely not fall under.

I also look for companies whose earnings are likely to grow faster or longer than the market expects. This requires a reasonable amount of judgment. But stocks that eventually exhibit such sustained growth are unlikely to see a compression in their valuation.

The Good Investors’ Conclusion

If you’ve been avoiding stocks because of the fear of the risk of loss, don’t.

Warren Buffett says that “risk comes from not knowing what you are doing.”

If we pick stocks wisely, the risk of permanent loss becomes small. On top of investing in stocks that exhibit low-risk qualities, investors should also consider diversifying their portfolio. Diversification reduces the risk that a single mistake or an unforeseen circumstance will be detrimental to our overall portfolio.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Common Investing Pitfalls

Investing can be hugely rewarding. But we need to be able to navigate behavioural tendencies that may cause poor investing decisions.

Taking control of your own finances can be hugely rewarding. But it is also permeated with investing mine traps that could potentially derail your returns.

Even seasoned investors and professional portfolio managers are not immune to these pitfalls.

Many of these are innate behavioral human tendencies that create delusions and lead to investment errors.

Jason Zweig, the author of the best selling book, Your Money and Your Brain, said, “Humankind evolved to seek rewards and avoid risks, but not to invest wisely. To do that. You’ll have to outwit your impulses – especially the greedy and fearful ones.”

With that said, here are three common human tendencies that may impact our investing.

Making gross generalisations

The human brain makes sense of the world by recognising patterns. But when it comes to investing, assuming a pattern when there really isn’t one could be detrimental.

Carolyn Gowen, a well-respected financial advisor, recently wrote in her blog that “in investing, we often mistake random noise for what appears to be a non-random sequence.”

To lower the chance that we mistake a random sequence for a pattern, we should look for real economic reasons behind a correlation.

Second, never rely on short-term data. Investing should be viewed in decades, rather than months or years.

Herd mentality

Humans are social creatures. We want to be included and accepted. It is, therefore, not surprising that herd instinct is a common phenomenon in investing.

Investors need positive reinforcement to make decisions. We want to be verified by advice and what others are doing.

The end result is an investment decision that is not the result of individual choice. The tulip mania is a classic example of herd mentality. Towards the end of the 16th century, the demand for Dutch tulips skyrocketed. Investors, eyeing a quick buck, flocked in to buy tulip futures. The price of tulips skyrocketed before the bubble finally burst in 1937.

John Huber, manager of the Saber Capital Fund said, “My observation is that independent thought is extremely rate, which makes it valuable… Understanding this reality and being aware of our own human tendencies is probably a necessary condition to investment success in the long run.”

Self-serving bias

The self-serving bias is a common cognitive bias that distorts an investor’s thinking. In essence, the self-serving bias leads us to credit ourselves for successes but blame failures on other causes.

This delusion perpetuates poor investing decisions and limits our ability to learn. Not knowing what you don’t know is probably the single most dangerous flaw in investing.

The best defense against this cognitive bias is to review each investment decision and see if your investment thesis had played out in the first place. Were your investment successes built around solid fundamental reasoning or was it pure luck?

Keeping an investing journal can help us keep track and review our investing decisions.

The Good Investors’ Conclusion

Billionaire hedge fund manager, Seth Klarman, once observed:

“So if the entire country became security analysts, memorized Ben Graham’s Intelligent Investor, and regularly attended Warren Buffett’s annual shareholder meetings, most people would, nevertheless, find themselves irresistibly drawn to hot initial public offerings, momentum strategies, and investment fads.

Even if they somehow managed to be long-term value investors with a portion of their capital, people would still find it tempting to day-trade and perform technical analysis of stock charts. People would, in short, still be attracted to short-term, get-rich-quick schemes.”

Being rational is easier said than done. We humans are built in a way that has helped us survive for thousands of years by making decisions based on fear and greed. So going against these human emotions is innately difficult.

But to be good investors, we need to appreciate and overcome these human emotions and biases. By overcoming our emotions and biases in investing, we are more likely to make sound investing decisions that give us the best chance of long-term investing success.

Does Your REIT Manager Have Your Interests at Heart?

REITs are a popular investment vehicle that provide regular cash flow. But REIT managers may pursue goals that end up harming investor returns.

Real Estate Investment Trusts (REITs) are increasingly popular in Singapore. Besides providing exposure to real estate at a low starting capital outlay, REITs also offer portfolio diversification, enjoy tax incentives, and offer relatively high yields.

But REITs are by no accounts perfect.

One flaw is that some REITs’ managers may not be specifically incentivised to increase their REITs’ distribution per unit- the metric that is most important to unitholders.

Because of this misalignment in interest, REIT managers may be tempted to pursue goals that end up harming unitholders. I did a quick review of some REITs in Singapore to compare how their managers are incentivised.

Misaligned interests?

For instance, Frasers Logistics and Industrial Trust’s manager is paid a performance fee that is 5% percent of the REIT’s annual distributable income. Mapletree Industrial Trust and Keppel REIT’s managers are paid a performance fee of 3.6% and 3% of the net property income, respectively.

At first glance, investors may think this is a fair practice, since it encourages the managers to grow their respective REITs’ distributable income and net property income. But the reality is that an increase in either of these may not actually result in an increase in distribution per unit (DPU).

In some cases, the net property income and distributable income may rise because of the issuance of new units to buy new properties, without actually increasing DPU.

Keppel REIT is a prime example of a REIT whose unitholders have suffered declining DPU in the past while its manager enjoyed high fees.

Performance fees aligned with unitholders

That said, there are REITs that have good performance fee structures.

For instance, Sasseur REIT and EC World REIT’s managers are paid a performance fee based on 25% of the difference in the DPU in a financial year with the DPU in the preceding year. In this way, they are only paid a performance fee if the DPU increases.

ESR-REIT has an even more favourable performance fee structure. They are paid 25% of the difference between this year’s DPU and the highest DPU ever achieved.

Base fees

We should also discuss base fee incentives. Besides performance fees, REIT managers are also typically paid a base fee.

The base fee may be pegged to asset value, distributable income, or net property income. The base fee helps the manager cover the cost of its operation. A base fee pegged to the size of the assets makes sense since a larger portfolio requires more manpower and overheads to maintain.

In my opinion, the base fee should be there to help cover the cost of managing the REIT, while the performance fee should be the main incentives for the REIT managers.

Based on a quick study of base fees, ESR-REIT and Mapletree Industrial Trust are two REITs that pay their managers a relatively high base fee of 0.5% of the deposited asset value. Sasseur and EC World REIT’s managers are paid a base fee structure based on 10% of distributable income.

Typically, investors should look for REITs that pay their manager a low base fee, which in turn incentivises the manager to strive to achieve its performance fees.

Conflicts of interests

As you can see, managers and minority unitholders of REITs may end up with conflicts of interests simply because of the way REIT managers are remunerated. If a manager is incentivised based solely on net property income, it may be tempted to pursue growth at all costs, even though the all-important DPU may decline.

On top of that, REIT managers’ are also often owned by the REIT’s sponsor. This might result in an additional conflict of interests between sponsors and REIT minority holders.

But having said all that, conflicts of interests may not always end up being bad for investors. Even if remuneration structures and interests are not aligned, an honest and fair sponsor might still feel obliged to treat minority unitholders fairly.

The Good Investors’ Conclusion

As retail investors, we have little power over the decision-making processes in a REIT. We depend almost entirely on the REIT manager. It is, therefore, essential that we invest in REITs who have managers that we trust will do what is right for us. So how do we do that?

The first step is to study the REIT’s manager’s remuneration package. Ideally, the REIT manager should be remunerated based on DPU growth. If the manager has poorly-aligned interests, you then need to assess if it has a track record of making honest decisions. Look at the REIT’s DPU history. Has it allocated capital efficiently and in a way that maximises DPU?

Too often investors overlook how important it is to have a manager that has the interests of minority unitholders at heart. Hopefully, this article brings to light the importance of having a good and honest sponsor and manager.

What Should Frasers Commercial Trust Unitholders Do Now?

Frasers Logistics and Industrial Trust is proposing to acquire Frasers Commercial Trust. Here’s a breakdown on possible scenarios and what actions to take.

Frasers Logistics and Industrial Trust has proposed to acquire Frasers Commercial Trust in a shares plus cash deal. In essence, Frasers Commercial Trust unitholders will receive 1.233 Frasers Logistics and Industrial Trust units and S$0.151 in cash for every unit of Frasers Commercial Trust they own.

In light of the proposed deal, I had previously shared my thoughts on what it means for Frasers Logistics and Industrial Trust’s unitholders. Below are my thoughts on what the merger means for Frasers Commercial Trust’s unitholders.

Scenario 1: The proposed deal goes through

Existing unitholders of Frasers Commercial Trust can accept the offer tabled to them. In exchange, they will receive cash and units of the new REIT. This outcome could be fairly rewarding.

For one, there are reasons to believe that the new REIT can provide solid returns for unitholders. If the deal does go through, Frasers Commercial Trust unitholders will be able to participate in the new REIT’s potential upside.

The new REIT is expected to provide a 6% distribution yield (if you consider the market price at the time of writing of S$1.23 per unit). The enlarged REIT will benefit from a diversified portfolio with the potential to grow its rental income organically.

The deal will also enable Frasers Commercial Trust’s unitholders to cash out a portion of their holdings, due to the cash portion of the acquisition.

Scenario 2: The proposed deal gets rejected

If the deal gets rejected by either party, it will not go through. In that case, Frasers Commercial Trust unitholders get to keep their stake in the existing REIT.

I think the main reason why Frasers Commercial Trust unitholders may reject the deal is that they may not view the purchase price to be high enough. They will also be receiving new units of the enlarged REIT at fairly high prices. Based on current market prices, the new units will be issued at a 29% premium to book value.

Scenario 3: Unitholders can sell their units now

Unitholders of Frasers Commercial Trust can also sell their units before the results of the deal. By selling your units, you can get the cash out immediately and reinvest elsewhere.

This option is for unitholders of Frasers Commercial Trust who do not want to hold on to the units of the newly formed REIT.

This is a reasonable action to take if you have found an investment that is better suited for your portfolio.

Scenario 4: Looking for arbitrage opportunities

The fourth option is to make use of the deal as an arbitrage opportunity.

Although I encourage long-term, buy-and-hold investing, mispricings in the market, especially after a deal has been proposed, can result in the opportunity to make an immediate profit.

To understand how to do this, we must first look at the mechanics of the deal. Frasers Commercial Trust unitholders will be getting 1.233 Frasers Logistics and Industrial Trust units plus 15.1 Singapore cents.

At the time of writing, Frasers Logistics and Industrial Trust shares trade at $1.23 per unit. As a result, the market value of what Frasers Commercial Trust unitholders will receive ($1.667 per unit) is slightly lower than the current market price of $1.67.

As such, investors can instead choose to sell their holdings in Frasers Commercial Trust and purchase Frasers Logistics and Industrial Trust. Of course, they should factor in whether it still makes sense after including any transaction costs (it might not, depending on the broker you use).

The Good Investors’ Conclusion

The proposed acquisition of Frasers Commercial Trust has given its unitholders a lot to think about. Should you simply wait for the deal to pass and enjoy the upside of the enlarged REIT? Or should investors take active steps to achieve a better return by seizing the current arbitrage opportunity? The risk of trying to maximise returns through arbitrage is that the deal falls through.

Additionally, unitholders who do not want a stake in the enlarged REIT can also choose to encash their units now.

Personally, I think trying to make an arbitrage profit is too much effort for too small of an upside (this may change if either REIT’s unit price moves dramatically, which is unlikely as arbitragers will force the price to equilibrate). So for now, I think it is best for Frasers Commercial Trust unitholders to simply wait for the outcome of the deal.

There are potential pros and cons to either outcome. If the deal goes through, exiting Frasers Commercial Trust unitholders can enjoy distribution per unit-accretion, if they reinvest the cash portion of the deal into Frasers Logistics and Industrial Trust. The new trust will also enjoy potential economies of scale, access to cheaper debt, and potentially trade at higher valuations. The downside is that the new units are being issued at a fairly high valuation of 1.29 times book value and the purchase price is fairly low.

Conversely, if the deal falls through, unitholders will continue to hold onto their Frasers Commercial Trust units, which also has a good portfolio of properties, low gearing, and could potentially pay out higher distribution per unit in the future. However, unitholders will miss out on the yield-accretion and the potential to participate in the growth opportunity of a larger, more liquid REIT with access to cheaper debt and equity.

3 Essential Investing Lessons From a Top-Performing Fund Manager

John Huber’s fund has more than doubled the S&P500 index. Here’s a compilation of three investing lessons from his annual letters and blog posts.

John Huber is one of the top-performing fund managers of the decade. His Saber Investment fund has achieved a gross annualised return of 20.66% since 2014. That puts his fund well ahead of the S&P 500 which has annualised at 10.89%.

I spent my weekend studying some of Huber’s letters to shareholders and blog posts. Here are three investing lessons from his writings.

Time is a valuable edge

Fund managers often get asked the question, “what is your edge”? The two main responses that institutional investors look for are some sort of “information” or “analytical” edge.

However, Huber believes that in an era of easily-accessible information, both these edges do not exist anymore. Huber explains:

“I’ve observed over the years that whatever information an investor believes to be unique is almost always understood by many other market participants, and thus is not valuable.

The mispricing is not in the stock itself, but in the investor’s own perception of the value of information: it’s worth far less than they believe it is. Information is now a commodity, and like the unit price of computing power that provides it, the value has steadily fallen as the supply and access to it has skyrocketed.”

But the absence of an “informational” or “analytical” edge does not mean stock pickers cannot outperform the market. Huber believes that the “time horizon” edge is still alive and kicking.

The “time horizon” edge is formed because today’s market participants are more interested in short-term gains over the long-term. Huber notes that many investment firms today make investing decisions based entirely on short-term stock price movements. These decisions have nothing to do with long-term value.

This creates a huge pricing mismatch between a stock’s long-term value and the current stock price. In turn, it creates a massive opportunity for long-term investors to outperform the market.

But the “time horizon” edge does come with its price. Huber explains:

“The price of gaining this edge is the volatility that could occur in the near term. You have to be willing to accept the possibility that your stock will go down before it goes up. Very few investors are willing to pay that price, which is why even large-cap stocks can become disconnected from their long term fair values.”

Don’t be afraid to say, “I don’t know”

Huber wrote a great article on one of Warren Buffett’s underrated investment attributes: His ability to recognize when a situation is outside of his well-defined circle of competence.

Buffett has been able to do extremely well in the stock market simply by focusing on more-certain bets and resisting everything else.

The ability to say “no” has enabled Buffett to have very few major mistakes on his record.

More impressively, Buffett is also humble enough to admit when he is wrong. For example, his ability to realise his mistakes led him to make smart investment exits in IBM, Tesco, and Freddie Mac. Huber wrote:

“I think the vast majority of investment mistakes can be traced back to the inability to be honest about your own knowledge or level of understanding about a subject matter.

It’s hard for smart people who have spent their lives being right far more often than they are wrong to admit to themselves that something is too challenging.

It is even harder to admit that their original assessment was completely wrong. So I think intellectual honesty can be a source of a powerful edge for those who can harness it to their advantage.”

Individual thought is essential

Huber also explains that one of the biggest risks in investing is allowing others to indirectly make your investment decisions.

Too often investors rely on outside advisors to make an investment decision. But the advice may be based on different economic interests, investment horizons, or goals.

Investors also tend to copy high-profile investors. However, high-profile investors can also occasionally make mistakes.

Theranos, one of the most high profile fraud cases of the decade, managed to secure billions in funding before it was eventually found out. Its early investors were some of the most respected business people of our time. They included the likes of Carlos Slim, Robert Kraft, Larry Ellison, Rupert Murdoch, and the Walton family. Huber notes:

“My observation is that independent thought is extremely rare, which makes it very valuable.

On the other hand, outsourced thinking appears to be pervasive in the investment community, and because of how we’re wired, this dynamic is unlikely to change. Regardless of how convincing the facts are, we are just more comfortable if we can mold our opinion around the opinion of others.

Understanding this reality and being aware of our own human tendencies is probably a necessary condition to investment success in the long run.”

Why Frasers Logistics and Industrial Unitholders Should Be Pleased With The Proposed Merger With Frasers Commercial Trust?

Frasers Logistics and Industrial Trust has proposed a move to acquire Frasers Commercial Trust. Is it good for existing unitholders?

The proposed merger of Frasers Logistics and Industrial Trust and Frasers Commercial Trust is the latest in a flurry of mergers among Singapore REITs this year. But not all mergers are good for shareholders (technically, REIT investors are called unitholders but let’s not split hairs here).

To determine if the proposition is fair to Frasers Logistics and Industrial Trust shareholders, I did a quick analysis of the deal.

[Note: An article discussing what the merger means for Frasers Commercial Trust shareholders was published on 10 December 2019. You can find it here.]

Details of the deal

In essence, Frasers Logistics and Industrial Trust will be absorbing Frasers Commercial Trust. It will pay S$0.151 in cash plus 1.233 new units of Frasers Logistics and Industrial Trust for every Frasers Commercial Trust unit.

In addition, Frasers Logistics and Industrial Trust is proposing to purchase the remaining 50% freehold interest in Farnborough Business Park that is not already owned by Frasers Commercial Trust.

Is Frasers Logistics and Industrial Trust Overpaying?

A share-plus-cash deal can be complicated to process. That’s why I prefer to break it into two parts. First is the issuance of new shares, and second is the purchase of the REIT using existing cash and the capital raised from the fundraising exercise. I will address each of these separately.

Frasers Logistics and Industrial Trust is issuing new shares at a premium to its book value. The new shares (if you consider that they are issued at market prices of $1.23), is 29% higher than Frasers Logistics and Industrial Trust’s current book value per share of S$0.95. Additionally, the new shares are being issued at a trailing annualised dividend yield of 5.8%, which is quite low for a REIT. Because of the relatively high price of the new shares issued, I think the issuance of new shares is positive for existing shareholders of Frasers Logistics and Industrial Trust.
That brings us to the second part of the assessment- the price paid for Frasers Commercial Trust. Based on the current market price of $1.23 for each Frasers Logistics and Industrial Trust share, it is paying $1.66 (1.23 x 1.23+0.151) for each Frasers Commercial Trust share. The implied price is just a 3.1% premium to Frasers Commercial Trust’s book value per share of $1.61. It is also lower than Frasers Commercial Trust’s current market price of $1.68 per share. I think this is a fair purchase price, considering the potential long-term benefits of the deal (more on this below).

Based on the above considerations, I believe the deal will benefit existing unitholders of Frasers Logistics and Industrial Trust.

Immediate impact on distribution per unit and NAV per unit

The new units are being issued at relatively high prices, and the purchase price is just a slight premium to book value. So it is not surprising that the deal is expected to have an immediate positive impact for Frasers Logistics and Industrial Trust. Management expects the acquisition to be accretive to both distribution and book value per unit.

The two charts below illustrate the pro forma accretion to book value and distribution per unit (DPU).

Source: Investor presentation for Frasers Logistics and Industrial Trust merger with Frasers Commercial Trust

Other benefits of the deal

Besides the immediate positive impact on DPU and book value per unit, there are also other potential benefits to the merger:

The enlarged REIT will likely be able to negotiate lower interest rates on its debt in the future
There are potential economies of scale due to the enlarged size of the combined REIT
The bigger portfolio will increase diversification and decrease concentration risk
The new properties absorbed by Frasers Logistics and Industrial Trust have favourable characteristics that could drive growth. For instance, 51.8% of Frasers Commercial Trust’s properties have step-up annual rent escalations of between 3.0% and 4.0%. Also, Alexandra Technopark, one of Frasers Commercial Trust’s six properties, also recently completed an asset enhancement work.

The Good investors’ conclusion

There are many reasons for existing shareholders of Frasers Logistics and Industrial Trust to like the deal. First, the deal will be immediately accretive to both book value and DPU per unit. Second, the enlarged REIT will benefit over the longer-term through economies of scale and diversification. In turn, this should provide the REIT with a longer runway for DPU-growth in the future.

5 Ways to Invest For the Greater Good

By choosing to invest in companies that are doing good for the world, we not only stand to profit but can also improve the world in the process.

Ser Jing and I started The Good Investors as a platform to raise awareness on how investors can invest well for themselves while doing good for the world. These two objectives are by no means mutually exclusive.

Driving growth

In his book Sapiens: a Brief History of Humankind, Yuval Noah Harari devoted a whole chapter to how capitalism contributed to the modernisation and growth of the world’s economy. He wrote:

“Capitalism distinguishes ‘capital’ from mere ‘wealth’. Capital consists of money, goods, and resources that are invested in production. Wealth, on the other hand, is buried in the ground or wasted on unproductive activities.”

Capitalism is, hence, one of the driving forces of real economic growth over the last five centuries.

But free markets that are solely after profits can be detrimental to society. The slave trade, for example, was the product of free-market capitalism. Harrari wrote, “When growth becomes a supreme good, unrestricted by any other ethical considerations, it can easily lead to catastrophe.”

To prevent this, investors should focus on ethical investing, rather than simply chasing after profits. Investing responsibly can not only fuel economic growth but can also help drive innovation, promote good practices, and reverse climate change, among others.

Investors today are much more conscious of how they can do well while doing good. With that said, I have compiled a list of five ways investors can invest for the greater good.

1. Avoiding sin stocks

Tim Nash, the founder of Good Investing, describes negative screening as doing less evil. By avoiding sin stocks, capital allocators force companies to rethink their strategy and discourage entrepreneurs from moving into the controversial sector in the first place.

Each of us may have a different definition of sin stocks depending on our personal values. However, some commonly cited “sin stocks” include weapons, fossil fuels, and cigarette companies.

2. Investing in green technology

We can also actively invest in companies that are striving to make the world a better place.

Climate change is one of the biggest challenges of the world today. It is, therefore, no surprise that investors are now prioritising green technology more than ever. But the success of green technology can only be achieved if both investors and consumers are willing to back it.

Some examples of green technology include solar power, electric vehicles, water purification, and LED lights.

Thankfully, it seems that the world is moving in the right direction when it comes to green technology. In November 2019, the Singapore government announced that it will invest US$2 billion in funds that have a strong green focus.

3. Investing in necessities

In Singapore, we take clean water for granted. However, unsafe sanitation is still a massive problem in Africa. Unsanitary water contributes to more than 1,200 deaths of children under five years old per day.

The Bill & Melinda Gates Foundation has taken massive steps to alleviate the problem, through education and waste treatment technology.

Investors can contribute too. We can play our part by funneling our capital to companies that are helping to alleviate the sanitisation problem.

Besides water, investors can also consider supporting companies that champion basic human rights, promote education, enable sustainable farming, and others.

4. Innovative companies

Some companies are improving the lives of millions of people simply through innovative technologies.

Take Alphabet Inc, for example. The parent company of Google has increased its focus away from merely “organising information”. Today, the tech conglomerate has investments in healthcare and autonomous vehicles, and even provides the world with faster Internet access through fiber networks.

Many of us also probably also use some of Google’s other applications that make our lives much easier, like Google Maps, Gmail, Google Photos, and even Google Translate.

Alphabet is certainly not the only company making a difference to the world. Today, there are more tech companies than ever that are coming up with innovative solutions that are not only financially feasible but improving the lives of millions.

5. Healthcare

Another way we can invest for the greater good is by investing in healthcare companies. The pharmaceutical sector, for instance, is responsible for the innovation of numerous drugs that have saved the lives of millions.

However, pharmaceutical companies require bucketloads of cash to fund research and clinical trials.

While the biggest pharmaceutical companies are self-sustainable through the money earned from earlier blockbuster drugs, many are still in their infant stages. Such firms are desperately in need of capital.

Investors can help to fund research by investing in these companies. There is also the potential of profit should one of the pipeline drugs get commercialised.

Doing well while doing good

Contrary to popular belief, investing need not be solely for enriching yourself. By selectively investing in companies that are doing good for the world, we not only stand to profit but can also improve the world in the process.

My hope is that more investors use their capital not only as a means to enrich themselves but also for the greater good of the world.

REITs and The Power of Cheap Equity

REITs that have access to cheap equity are more likely to do well over the long term. Here’s why.

I’ve been studying real estate investment trusts (REITs) for some time. One thing that I noticed is that access to cheap equity is an often overlooked but powerful tool for REITs to grow.

“Cheap equity” is a REIT’s ability to raise money at a comparatively low cost.

The benefits of cheap equity

So how does cheap equity arise? First, the investing community needs to be bullish on a REIT. Usually, the REIT will exhibit some of the positive characteristics I tend to look for. The market realises the REIT’s potential and prices its units up. Such REITs end up being priced at a premium to its book value.

The high unit price of the REIT’s units creates an opportunity for it to raise money cheaply. Simply by issuing new units at this high price, the REIT is able to boost its book value per unit and its yield.

A prime example

Let’s consider a recent example. Mapletree Commercial Trust is a REIT that has been trading well above its book value for many years. In October 2019, the REIT decided to make use of its high unit price to raise cheap capital. It announced that it would raise around S$900 million to partially fund the acquisition of a property, Mapletree Business City (Phase2).

The new units were priced at S$2.24 each, well above Mapletree Commercial Trust’s book value per share of S$1.70 (as of October 2019). In addition, the REIT’s new units were issued at a low annualised yield of 4.1%.

There are two key advantages here. First, because the units were priced above book value, the equity fundraising will immediately increase the REIT’s book value per unit. Second, the funding exercise will be distribution per unit-accretive to shareholders as long as the new property purchased has an asset yield of more than 4.1% (or even less if you consider that part of the acquisition will be funded by debt).

A virtuous cycle

The ability to raise money cheapy creates a virtuous cycle for such highly regarded REITs.

Consider the case of Mapletree Commercial Trust:

Investors are bullish on Mapletree Commercial Trust’s prospects and attach a high valuation to it.
The REIT uses the opportunity afforded by its high unit price to issue new shares.
Backed by a strong sponsor, Mapletree Pte Ltd, and positive public sentiment, the REIT is able to raise new funds through an equity fundraising.
As the new units were issued at a high price, the fundraising is immediately-accretive to book value and distribution per unit.
Investors see the growth in DPU and book value per unit and become even more bullish on the REIT and the market pushes the price of the REIT higher. The REIT is now able to raise more capital cheaply.

This whole process creates a virtuous cycle that helps highly-regarded REITs keep on growing.

How investors can benefit

The lesson here is not to be put off by REITs that have relatively high unit prices. A REIT with a high unit price may not offer the best yield but it has the ability to grow much faster than its peers. Having said that, this is by no means a fool-proof scenario.

Investors will also need to pick the REITs that are best able (and willing) to make use of the opportunity afforded to the REIT through its high unit price. One of the key things to look out for is the REIT’s track record of raising equity and whether it has a sponsor with deep pockets.

The REITs that are sponsored by CapitaLand, Mapletree and Frasers have, historically, been some of the best REITs in Singapore’s stock market to own. These three sponsors have been willing to support their REITs through capital injections, even at high valuations.

Knowing this, shrewd investors who spot this trend can capitalise and ride the virtuous upcycle driving well-regarded REITs.

Why I Invested in Sasseur REIT

Sasseur REIT has been one of the top-performing REITs so far this year. Here is my thought process behind my decision to invest in it in March this year.

Sasseur REIT has been one of the top-performing Singapore-listed REITs this year, with a year-to-date return of more than 40%.

I invested in Sasseur REIT in March this year at a purchase price of 72 cents per share. Today, the stock trades at around 88 cents. In addition to the capital gain, I have also collected 4.9 Singapore cents in dividend (technically called a distribution but let’s not get nit-picky).

In this article, I will explain my investment thesis for Sasseur REIT and whether I think it is still worth a look at today.

Company description

Sasseur REIT owns four outlet malls in China. The REIT is sponsored by Sasseur Group, a privately-owned outlet mall operator that currently manages and operates nine outlet malls.

The China-based REIT was listed in Singapore on 28 March 2018. Since listing, Sasseur REIT has performed well above expectations. It beat its initial public offering forecast for seven consecutive quarters, both in terms of rental income and distribution to unitholders.

My 5-point framework

Over the years, I have built a five-point framework for investing in REITs. I try to invest in REITs that tick as many of the boxes as possible.

As a quick summary, the REITs I invest in should have (1) a good existing portfolio, (2) capable and honest management, (3) a safe capital structure, (4) a fair and responsible sponsor and (5) a decent valuation.

I will describe my investment thesis for Sasseur REIT using this REIT framework.

1. A good existing portfolio

In my view, Sasseur REIT has an excellent existing portfolio.

To understand the REIT’s portfolio better, we need to appreciate its unique mode of managing the four malls it owns. The REIT effectively outsources the management of the mall to a third party called the entrusted manager.

Favourable entrusted manager agreement

The entrusted manager is responsible for maximising the rental income of the assets. It collects the rent and pays Sasseur REIT an entrusted manager agreement rental income.

This comprises a fixed and a variable component.

There are a few things to like about this arrangement. First, the fixed component ensures a baseline level of rental income that is more or less guaranteed every year. The fixed component will also rise each year.

Second, the variable component gives Sasseur REIT the opportunity to participate in the upside, should tenant sales rise.

Increasing tenant sales

There are a few reasons to believe that tenant sales will increase in the long run. For one, total VIP members (a membership program to reward high-spending customers) have jumped a staggering 70% from the end of 2018 to 30 September 2019. Second, two of the REIT’s malls are still relatively new and should attract more shoppers as they mature.

There are also macro-economic tailwinds. China’s GDP is expected to grow by more than 6% in 2019 and 2020. The GDP growth, in turn, is expected to fuel a rise in the middle-income population in China, which will drive demand for discounted branded goods.

Sasseur REIT’s four malls demonstrated impressive growth in 2019. In total, the four malls generated a 20.9% growth in tenant sales in the first three quarters of 2019.

Positive portfolio characteristics

The occupancy rate at Sasseur REIT’s malls is also very high, averaging at 95.4%. This is a sign that the REIT is able to attract tenants to its malls.

The REIT has deliberately short tenant leases, which give the managers more flexibility to improve the tenant mix and to increase rent in the future.

Potential downsides

There are, however, two downsides to Sasseur REIT’s existing portfolio. First, its four malls are leasehold. The tenures range from 27 to 35 years. Second, the REIT owns only four malls so there is an element of concentration risk. Nevertheless, I think its current portfolio still possesses more pros than cons.

2. A capable and honest management

Sasseur REIT has a relatively short track record as a listed REIT. Despite its short history, I think the way the managers are incentivised gives me confidence that they have minority shareholders at heart.

First, the entrusted manager has shown a good track record of growing the portfolio’s tenant sales. In addition, resultant rent, and consequently distribution per unit, have beaten expectations each and every quarter since the REIT’s listing. I am more inclined to trust managers that underpromise and overdeliver.

Additionally, both the REIT manager and the entrusted manager have incentives that are aligned with shareholders’ interest.

The entrusted manager is paid a base fee that is calculated as the lower of (1) 30% of gross revenue or (2) gross revenue minus EMA Resultant rent (what is paid to Sasseur REIT).

In essence, the entrusted manager is entitled to the leftover of gross revenue after paying what it owes to Sasseur REIT. However, this amount is capped at 30% of gross revenue. If there is left-over after the base fee and EMA resultant rent is paid to Sasseur REIT, the entrusted manager is then entitled to 60% of the leftover amount as a performance bonus.

From the way the entrusted manager is incentivised, it is clear that it is in the entrusted manager’s interest to try to grow gross revenue for the REIT, which is ultimately also beneficial to the REIT unitholders.

The REIT managers also have a base fee and a performance fee. The REIT managers are only entitled to the performance fee if it achieves distribution per unit (DPU) growth over the previous financial year.

3. A safe capital structure that can be optimised

Sasseur REIT has a gearing ratio of 29.0%, well below the regulatory ceiling of 45%. This gives it the debt headroom to take more loans to invest in new properties.

The REIT’s cost of debt is also manageable at 4.43% (reasonable by China standards). The relatively low interest rates give it an interest coverage of 4.8 times.

I also take heart in the fact that the manager has emphasised that they are going to be using the REIT’s financial muscle prudently. The manager will only look at yield-accretive acquisitions that can benefit unitholders over the long-term.

4. A fair and responsible sponsor

As a first-time REIT sponsor, investors don’t have much information to judge Sasseur Limited.

However, the sponsor has not interfered much in the way that Sasseur REIT has been run. It has not shown that it will treat minority shareholders unfairly.

On top of that, the sponsor also has a lineup of right-of-first-refusal properties in its portfolio that Sasseur REIT can tap on for future acquisitions.

As one of the largest outlet mall operators in China, it also boasts the experience and know-how that Sasseur REIT can use as it seeks to expand its portfolio in the future.

Based on and despite the limited information I have, I am fairly satisfied with the sponsor.

5. A decent valuation

Valuation is the final aspect to consider. Sasseur REIT has seen its share price soar over the past 12 months. It currently sports an annualised distribution yield of 7.4%.

When I bought it earlier this year, the REIT had a yield of 9.8%. Based on the lower yield today, the REIT seems expensive now.

But investors should note that at the time of writing, REITs in Singapore have an average yield of around 6%. This makes Sasseur REIT’s current 7.4% yield look comparatively cheap. As such, it may be that Sasseur REIT was trading at an unfairly low valuation earlier this year, rather than an overly rich price today.

The Good Investors’ Conclusion

Despite the recent run-up in price, Sasseur REIT still looks like an attractive stock to hold. The REIT ticks many of the right boxes and seems primed to continue increasing its distribution per unit.

There are risks to note. The REIT has high concentration risk, currency risk and is highly dependent on economic tailwinds. But despite these risks, I think the REIT’s positive traits and growth potential still give me an excellent risk-reward profile.

Why It’s So Hard To Be a Contrarian Investor

Being greedy when others are fearful is easier said than done. Most investors may say they would do it but few actually practice it.

In the last downturn, how many of us actually had the courage to buy stocks when everyone else was selling? So why is it so hard to act against the grain?

Fundamentals change too

When we think of market downturns, we usually imagine a world where nothing changes except for stock valuations. The reality, however, is nothing like that. Morgan Housel from the Collaborative Fund explains:

“The reason you may embrace ideas and goals you once thought unthinkable during a downturn is because more changes during downturns than just asset prices.”

Take 2008 for example. Stock prices fell hard, but not without reason. The subprime mortgage crisis in the United States developed into a full-blown international banking crisis. Previously sound banks failed, companies went broke and consumer spending plunged.

These are fundamental changes that caused a decline in company earnings, huge layoffs and reduced consumer wealth.

In such times, it is easy to see why investor confidence was sapped.

People need positive reinforcement

Even when we do think differently from the crowd, most of us are not able to act on it. People require positive reinforcement to take action.

For instance, when we are bullish on a stock, we need encouragement from external sources. We seek out positive reinforcement in the mode of brokers’ opinions, analysts reports, or even friend’s approval.

However, in a time when everyone is fearful, positive reinforcement is hard to come by.

Fear is hard to ignore

Emotions also play a huge part in our investment decisions. When we start investing, we often tell ourselves to ignore emotions and to focus on facts. But, unfortunately, it is extremely difficult to tune out emotions completely.

In his book The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy, investor James Montier said, “It turns out there are numerous human traits that push us toward conformity and away from individual thinking.”

He explains that neuroscientists have found that when individuals take the road-less-travelled, they experience fear. Fear is there for a reason. It is a defense mechanism that is built to protect us. Acting against our fears, is thus, innately difficult.

As such, it is no wonder that fear plays a big part in our investing decisions. When the stock market is raging, investors have a fear of missing out (FOMO), while the fear of losing money makes people sell in a bear market.

Contrarian Thinking

“ …don’t be led astray by Wall Street’s fashions, illusions and its constant chase after the fast dollar. Let me emphasize that it does not take genius to be a successful value analyst, what it needs is, first, reasonably good intelligence; second, sound principles of operation; and third, and most important, firmness of character.”
Benjamin Graham

It is not difficult to see why contrarian investing is so challenging. If it were easy, it wouldn’t be called “contrarian” in the first place. But on the other end of the spectrum, simply being contrarian for the sake of it, is also extremely detrimental. We need to seek the right balance.

For us to be a successful contrarian investor, we need three key characteristics: The ability to digest and analyst facts; individual thinking; and the courage to overcome fear. If you master these three traits, you will likely reap the rewards in the future.