REITS Follow-Up

Following up from my post on REITs here on 20 Aug 2023, where I had named three REITs that I would look to add positions to, and I had managed to buy into them since then, namely:

• Frasers Logistics & Commercial Trust (FLCT) (21 Aug 2023, SGD 1.16)
• Paragon REIT (Paragon) (15 Sep 2023, SGD 0.895)
• Frasers Centrepoint Trust (FCT) (20 Oct 2023, SGD 2.06)

 

The prices for FLCT and Paragon had since gone further down, due to the foreseeable sustained level of current interest rates spooking the REIT (and in general property) asset class. It is a heartache but as I had mentioned, it is impossible to catch the bottom and low can go lower. For disclosure, as of 25 Oct 2023, our overall position based on price (no dividends) for FLCT, Paragon and FCT stood at -4.83%, -11.3% and +2.76% respectively.

 

Two main developments had occurred after my 20 Aug 2023 post, and both came from FCT. First is the near-total divestment of their Hektar REIT holdings. The second is the divestment of Changi City Point, in which the latter’s disposal would bring FCT’s aggregate leverage down from 40.2% to 37.1%, improve hedge ratio of fixed interest rates from 63% to 73%, and reduce average cost of borrowings from 3.7% to 3.6%. These are good statistics in the wake of high interest rates.

 

With prices of FLCT, Paragon and FCT (25 Oct 2023) standing at SGD 1.03, SGD 0.80 and SGD 2.11 respectively, I would be more inclined in adding more Paragon, as FCT is hitting our portfolio’s 12% limit and FLCT’s high exposure to overseas properties.

 

Disclosure

 

The Bedokian is vested in FLCT, Paragon and FCT.

 

Disclaimer

Low Unemployment Is Not Good?

Just yesterday, the United States (U.S.) jobs report for the month of September was out.

The numbers, in short:

 

• Non-farm payrolls were up 336,000 against the expected 170,000.
• Unemployment rate was fairly constant at 3.8%
• Labour force participation remained unchanged at 62.8%.

 

The U.S. market’s reaction was quick; within moments of the report’s release, the yields of the U.S. treasuries and bonds rose, the index futures went down and the U.S. dollar had strengthened.

 

To a layman, having a low unemployment rate is good, which is a healthy sign of the economy in general. However, in the current context of high inflation, this is not a good sign.

 

And yes, that not-so-good-sign comes in the form of interest rates.

 

Of Hypotheses And Theorems

 

Economics and markets in general are paradoxical; we can use hypotheses and theorems to explain certain relationships, yet they are not totally valid and reliable in explaining everything.

 

One of the macroeconomic concepts out there is the Philips Curve, which stated that there is an inverse relationship between inflation and unemployment. This meant that when unemployment goes down, inflation goes up, and vice versa. Though sound, the Philips Curve did not manifest much during the 1970s when the U.S. experienced high unemployment and high inflation, becoming what was known as stagflation.

 

Another view is that higher participation in the labour market implies heightened economic activity in the form of increased incomes and demand, which in turn could drive inflation higher; this can be explained from the simple demand-supply curve.

 

Now you know why the markets reacted as described in the previous section when the jobs report came out.

 

In gist, when unemployment is low, it hints that inflation is, ceteris paribus, still high, which in turn the Federal Reserve (the U.S. central bank that governs interest rates) would, barring any other conditions, either raise interest rates or remain them as at the current level. High interest rates are no good for the equities markets and long dated bonds, but good for holding the U.S. dollar.

 

Note For The Bedokian Portfolio Investor

 

Such macroeconomic stuff sits at the top level of the Bedokian Portfolio’s  fundamental analysis model, which is economic conditions¹. While these things are beyond our control, it is good to know and acknowledge them so that you can have a situational awareness of your investment portfolio going forward. This is the reason why I preferred that, before one starts on investing, it is good to have a basic grasp of economics.

 

 

1 – The Bedokian Portfolio (2^nd ed), Chapter 11.

Comparing S&P 500 And Berkshire Hathaway

One of the reasons why I had recommended S&P 500 and Berkshire Hathaway (Berkshire) was that both were representative of the United States (U.S.) market, so in my opinion they are good choices for newbies to enter it.

The other reason for their inclusion, something which I did not highlight much about,

was their relative performance with each other; a comparison between the two as stated in the latest Berkshire letter to shareholders, over a 58-year period from 1965 to 2022, Berkshire returned compounded annual gain of 19.8%, as compared to S&P 500’s 9.9%¹. A USD 100 investment into Berkshire in 1965 will return around USD 2.42 million as at the beginning of 2023 versus S&P 500's roughly USD 22,400².

 

A Relook

 

For a more recent analysis, using Portfolio Visualizer, I had pulled out an in-depth view of the two counters. Available data for Berkshire Hathaway Class A share between Jan 1986 and Dec 2022 (Class A was chosen as it had a longer history than Class B, which was issued in 1996) was compared with the Vanguard 500 Index Fund Investor, acting as a proxy for the S&P 500.

 

During this period, Berkshire's compounded annual growth rate stood at 15.23% against S&P 500's 10.42% (see Figure 1). Looking at rolling returns, which is of interest to long term investors, the average 10-year and 15-year for Berkshire stood at 14.30% and 12.87% respectively, with S8P 500's average 10-year and 15-year at 9.93% and 8.54% respectively (see Figure 2).

 

Fig.1: Returns and other data between Berkshire Hathaway and Vanguard 500 Index Investor, Jan 1986 to Dec 2022. Source: Portfolio Visualizer. Click to view larger.

Fig.2: Rolling returns between Berkshire Hathaway and Vanguard 500 Index Investor, Jan 1986 to Dec 2022. Source: Portfolio Visualizer. Click to view larger.

 

Why The Difference?

 

Berkshire is currently helmed by two of the greatest investors known by many: Warren Buffett and Charlie Munger. Part of their successes can be attributed to their value investing methodology (discounted cash flow and intrinsic value), looking for great companies (having a wide "moat") and having the virtue of patience ("be fearful when others are greedy..."), to name a few.

 

Investing in Berkshire is like investing in an actively managed fund, just that you need not pay the high fees that are associated with it. Being a "fund", Berkshire has the discretion to buy and sell companies within its portfolio as it deems fit.

 

This is unlike the S&P 500 in which the investment vehicles following it (e.g., exchange traded funds, unit trusts, etc.) must at least replicate most of the holdings of the index itself, thus there is no freedom of selection.

 

Another overlooked aspect of Berkshire is it holds both public and private companies. You may have heard about it having close to 50% of holdings in Apple, but that does not mean 50% of Berkshire's invested funds are in Apple. Notable private companies under Berkshire's belt included See's Candies, Duracell and insurance companies GEICO and Gen Re. These private companies would have contributed further to Berkshire's returns. Also, it is from its insurance arm that Berkshire can garner the cash power to purchase equities using insurance float (difference between premiums and claims paid out).

 

Why Still Need S&P 500?

 

Despite the superiority of Berkshire's past performance over S&P 500, the latter is still included in a U.S. market beginner's toolbox. The reason is obvious: diversification.

 

Both Berkshire and S&P 500 represented different microcosms of the U.S. market and economy in general, and having them would be the closest thing in getting one's fingers dipped into the whole U.S. market and economic pie.

 

Furthermore, the management and investment decisions of Berkshire would have to be handed over to the next generation after Buffett and Munger, which there may be some deviations in investment methodology and decision-making process. The term “past performance does not indicate future results” is to be reminded of.

 

Contrasting to S&P 500, as an index, the inclusion of companies followed a set of requirements, which included market capitalisation, profitability and liquidity. This captures the essence of the microcosm analogy described above as the S&P 500 showed the current sectoral and industrial trend of the U.S.

 

And to conclude this post with a fact: S&P 500 contains Berkshire, too, and it is among the top 10 constituents by index weight³.

Disclosure

The Bedokian is vested in Apple, Berkshire Hathaway and S&P 500 via the SPY ETF.

Disclaimer

 

1 – Berkshire Hathaway Inc. Shareholder Letter 2022, p2. https://www.berkshirehathaway.com/letters/2022ltr.pdf (accessed 30 Sep 2023)

 

2 – Berkowitz, Bram. If You Have Invested $100 in Berkshire Hathaway in 1965, This Is How Much You Would Have Today. The Motley Fool. 3 Jan 2023. https://www.fool.com/investing/2023/01/03/if-invested-100-berkshire-hathaway-1965-how-much/ (accessed 30 Sep 2023)

 

3 – Equity S&P 500. S&P Dow Jones Indices. 31 Aug 2023. https://www.spglobal.com/spdji/en/idsenhancedfactsheet/file.pdf?calcFrequency=M&force_download=true&hostIdentifier=48190c8c-42c4-46af-8d1a-0cd5db894797&indexId=340 (accessed 30 Sep 2023)