Averaging Strategies

Averaging strategies are commonplace in the world of investing (and trading). The two straightforward averaging approaches are “average down” and “average up”. If you do not know what are the ups and downs, here is a brief introduction to these terms.

Average Down

According to Investopedia¹, the definition of average down is:

The process of buying additional shares in a company at lower prices than you originally purchased.

This averaging strategy is usually used by investors (and traders) when the price of their shares (and other financial instruments of other asset classes as well) goes below their original purchase price. By buying more of the shares at the lower price, the average price of the entire holding would be lower than the original purchase price.

For example, I had bought 100 shares of ABC Company at $1.00 each, totalling $100.00. A few months later, the price had gone down to $0.80. I then bought another 100 shares at $0.80, making it $80.00. In all, I have 200 shares of ABC Company worth a total of $180.00 ($100.00 + $80.00), or $0.90 per share ($180.00 / 200), thus averaging down from my original $1.00 position.

There are a few reasons for this averaging down. One of which is to bring the average price to a level where it is “nearer” to the current price, thus making it “easier” to exit at that price (quoting the above example, it is “easier” for a share price to go from $0.80 to $0.90, than from $0.80 to $1.00; do note my quoted easier, however). Another reason is the investor could buy the shares on the cheap.

Average Up

Average up is the opposite of average down, where it is the process of buying additional shares at higher prices.² Using the ABC Company example again, I had bought 100 of its shares at $1.00 each, totalling $100.00. A few months later, the price went up to $1.20, during which I bought in another 100 shares, paying $120.00. The average price now would be ($100.00 + $120.00) / 200 = $1.10 per share, averaging up from $1.00.

Investors typically use averaging up when they see there is a potential for a particular share to go further up, therefore adding more positions to it.

Are These Strategies Good for The Bedokian Portfolio?

There is nothing wrong with averaging down or up; a form of this strategy is being recommended for index investing³ in The Bedokian Portfolio. Also, in my previous blog post on rebalancing woes (see here), one of the solutions proposed is to add positions to current holdings, which will definitely involve some averaging down or up. Whether up or down, especially for individual equities, bonds and REITs, fundamental analysis⁴ and the selection guidelines⁵ must be adhered to.

1 – Investopedia. Average Down. http://www.investopedia.com/terms/a/averagedown.asp (accessed 29 Sep 2016)

2 – Investopedia. Average Up. http://www.investopedia.com/terms/a/averageup.asp (accessed 29 Sep 2016)

3 – The Bedokian Portfolio, p 60 & 122

4 – The Bedokian Portfolio, Chapter 11 – Fundamental Analysis

5 – The Bedokian Portfolio, Chapter 12 – Selection and Selling

Rebalancing Woes

Rebalancing is the act of bringing your portfolio back to its original allocation, therefore reducing your risks through diversification. It also helps to sell away good performing asset classes and buy in non-performing ones.¹

However, there are some occasions where it is a bit difficult to do rebalancing. The main reason for this is there is nothing in the non-performing asset class to buy in. For example, you needed to do rebalancing between equities and REITs. You have identified which equities to sell, but you cannot find any from the REIT side.

Still, rebalancing has to be done. You do not want to get caught out with an over-allocated asset class. To address the “rebalancing woes”, check out some of the recommended methods below.

Relooking at Current Holdings

The easiest option would be to add positions to your current holdings. At least there is some familiarity involved, since you need not go around looking for new ones, as long as your fundamental analysis of the holdings is still in the healthy range (come to think of it, if it is not in the healthy range, it would be sold off).

Exchange Traded Fund (ETF)

ETFs are another good way to address the issue.²  However, not every index out there is followed by an ETF. At the moment the S-REIT ETF is not available yet, so this method may not work well for the above example.

Temporary Withdrawal of Cash

During rebalancing, the asset class that gets increased temporarily would be cash. If no rebalancing is done, you would have a higher-than-allocated cash component, and this may cause a little problem to your ideal allocation. It would be prudent to move the excess cash out so that The Bedokian Portfolio goes back to the planned allocation. To do this, however, would “stunt” the growth of your Bedokian Portfolio, since the portfolio size is reduced and the “compounding magic” delayed. Good thing is, the withdrawal is temporary, and the cash amount withdrawn could be deployed in the next rebalancing schedule, which by then the economic situation may have changed and you would have more suitable choices to buy in.

1 – The Bedokian Portfolio, p 80

2 – The Bedokian Portfolio, p 122

Retail REITs – One interesting way to analyse

The three important attributes of a property, as the adage goes, are “location, location and location”. Especially for retail properties, this adage holds true.

For my analysis of retail properties, specifically in the context of REITs, I would expand the “three locations” into something more detailed; the location of influence, the location of competitors and the location of complements.

Before we begin, let us take out a map, and we use the Singapore map for reference, since we are more familiar with the local retail properties here. Next, on each of the retail property the REIT owns, draw a circle with a one kilometre radius.

With this circle(s) in place, we could clearly use the “three locations” for our analysis.

Location of influence

Back in our geography days, we had learnt something called “area of influence”, where a certain shop services a particular area. The location of influence is similar to this concept, and the circle on the map denotes the retail property’s potential visitors and consumers. The more concentrated the visitors/consumers is, the better the chance of the retail property being visited, ceteris paribus. A good example of a good concentration would be the property mall located within a dense residential area.

Location of competitors

If there are other retail properties within the circle (and also those which are outside of the circle but close to its borders) and they do not belong to the retail REIT concerned, these would be deemed as competitors. This means the visitors/consumers from this circle would have choices of visiting either the property in your analysis or somewhere else. However, do conduct further analysis on these competing properties to see if they are strong ones or not.

Location of complements

Other than competitors, there are also complements which may help the retail property in question. A good complement example would be the MRT station or bus interchange, where a retail property situated next to these would definitely bring in a high traffic of visitors/consumers. Another complement feature would be whether the retail property is situated along the tourist belt of Singapore (e.g. Orchard, City Hall, etc.).

The above presents one of the interesting ways of analysing retail REITs. Do take note of other factors (as described in The Bedokian Portfolio, Chapter 12 – Selection and Selling) before making the decision of transacting in the REIT.

ROE and ROA

I was alerted by some readers of The Bedokian Portfolio about certain important ratios that were missing from the book, and those are Return on Equity (ROE) and Return on Assets (ROA). Both of them are known measures of profitability. Before I explain why I had left them out, I shall explain what ROE and ROA are.

Return on Equity (ROE)

ROE is the amount of net income (total amount earned minus expenses, taxes and depreciation) returned as a percentage of shareholders equity. In other words, it is the profit generated using a given amount of shareholder equity. The formula for ROE is as follows:

Net Income / Shareholders Equity

The higher the percentage, the better the ROE is.

Return on Assets (ROA)

ROA is the amount of net income returned as a percentage of a company’s total assets.  Similar to ROE as the number is expressed in percentage, the comparison is now against all of a company’s assets, which includes the shareholder equity, and the formula for ROA is:

Net Income / Total Assets

The higher the ROA, the better the ROA is.

ROE and ROA In-Depth

Let us put in another basic accounting formula, and you could clearly see the relationship of ROE and ROA:

Total Assets = Liability + Shareholders Equity

This means if there is no liability (which is uncommon), ROE equals ROA. However, if the difference between ROE and ROA is huge, better check out the liability portion in the financial statements.

So Why No ROE and ROA in The Bedokian Portfolio?

What I am going to say next may invite brickbats, but the selection criteria highlighted in The Bedokian Portfolio are sufficient for a basic Bedokian Portfolio investor. The criteria of D/E ratio and current ratio for the coverage of liability are adequate. After all, legally and accounting speaking, dividends are to be paid from profits, and if there already is a dividend yield means there is profitability.

The ratios mentioned in the book are “…the more important ones…” (The Bedokian Portfolio, p86), meaning I do not diss away the other ratios, in this case the ROE and ROA. In fact, I encourage Bedokian Portfolio investors to take a step further in using other ratios to do their analysis further.

Further reading:

http://www.investopedia.com/terms/r/returnonequity.asp

http://www.investopedia.com/terms/r/returnonassets.asp