Today I decided to switch it up and actually write something money-related, because a bunch of y’all have been emailing me to ask abouuuuuttttt… REIT ETFs! (woot woot!)
This particular post is a little more technical than my usual ramblings, so if you don’t care very much about REIT ETFs, or if you’re already investing like a boss, don’t even worry about it. This is for the bunch of you who’re wondering if you should plonk your money into the REIT ETFs that have been popping up in Singapore this year like salted egg potato chips.
(Again, don’t take this as investment advice, don’t make decisions based on what some dude said on the internet, yadda yadda)
What The Heck Are REIT ETFs?
REIT ETFs are investments that let you invest into Real Estate Investment Trusts (REITs)
REITs pool investors’ money and invest it in a bunch of properties – like shopping malls, office buildings, warehouses, factory space, hotels, etc. The idea is that 1) Property appreciates over time, 2) Properties can be rented out for income, so therefore, LET’S TURN IT INTO AN INVESTMENT PRODUCT AND SELL IT TO THOSE PROPERTY-LOVING SINGAPOREANS$$$.
Okay, just kidding. Investopedia provides a much more balanced definition of how REITs work here.
This Sounds Amazing. Where Can I Invest All My Money NAO?
Not so fast. Remember that you should never invest all your money in a single asset class, no matter how attractive it sounds. Diversification is the name of the game, people.
Despite the usual arguments of “Singapore is land scarce so property sure make money wan”, the truth is nobody really knows what will happen to any asset class, whether it’s real estate, stocks, bonds, or bitcoin. (Yes, here’s looking at that one fanatical uncle who dominates the Christmas party dinner about how bitcoin will reach $1M next year)
Rule #1: Nobody can predict the future, so the best way to invest is to diversify across many different assets. It’s kinda like how it’s a bad idea to ONLY eat McSpicy burgers.
So! Yes, REITs might be an interesting asset class, but they should never make up your entire portfolio. Personally, they make up less than 10% of mine.
Okay, Let’s Talk Strategy, Man!
Active investing – the strategy of buying and selling stocks selectively – has largely been discredited. The story of how 90% of mutual funds fail to beat their benchmarks (and yet charge high fees) has been repeated so many times, it’s like Gordon Ramsay saying the word “stunning” on Masterchef.
(Sorry, couldn’t resist)
So! Since 90% of investors suck at active investing, the logical alternative is to do the opposite: Passive investing. That’s the strategy of saying, “Hey, I probably don’t know more than the multi-trillion-dollar financial markets, so I should just follow exactly what the market does.”
I’ve been harping about passive investing for years on this blog. REIT ETFs (and ETFs in general) have become more popular in part because of the rise of the passive investing movement.
The thing is, not all ETFs are created equal. Many ETFs might PRETEND to help you to “passively” invest but they’re actually just active or semi-active funds in disguise, hoping to jump on the passive investing bandwagon.
The Icky Technical Sidebar About Market-Cap Weighting
(This little digression explains how “market capitalisation weighted indexes” work. They’re important to passive investing and for our conversation later. If you already know what this means, feel free to skip over this long and icky technical paragraph)
A TRULY passive ETF follows what we call a “market capitalization weighted index” (or market-cap weighted for short).
This concept is well-established. Anyone who has taken a Finance 101 class will know that market capitalization = shares outstanding x price per share, assuming that you weren’t asleep during that class (which is a very big assumption, I know).
Market cap is simply a measure of how valuable a particular stock is to the economy. So if you take Apple, which is the largest market cap stock in the US, it’s easy to see that it’s a crazily important contributor to the US, and the global, economy. Compare that with a smaller company like Foot Locker (the 484th largest stock in the US) – not many people are going to lose sleep if Foot Locker goes out of business tomorrow.
Now, most traditional stock indexes are market cap weighted. Let’s take the Straits Times Index as an example. The STI has 30 stocks in it, but if you invest $100 into the STI, it doesn’t mean that your $100 is divided equally into each stock. Instead, there are different weights assigned to each stock based on what its market cap is relative to the rest of the STI.
For example, as I’m writing this, DBS has a weight of 14%, OCBC has 11.5%, UOB has 9.7%, Singtel has 9.3%, Jardine Matheson has 5.6%, and so on (source). So investing $100 in the STI means that you’ll invest $14 in DBS, $11.50 in OCBC, etc.
This makes sense. Remember that the philosophy of passive investing is to track the performance of the MARKET as a whole. And you can only do that if you allocate your money according to how valuable the market considers each company.
It doesn’t make sense to allocate more money than necessary to a particular stock like Foot Locker, unless you’re saying that you know something about Foot Locker that the rest of the multi-trillion dollar stock market doesn’t know.
In short, if you believe that: 1) You cannot beat the markets, 2) passive investing makes sense, then the only logical course of action is to invest in ETFs that follow a market-cap weighted index.
Whew. That was a long, tough explanation. Okay, now back to our topic.
Not All REIT ETFs Are Created Equal
This is how most people think when it comes to REIT ETFs:
Passive investing is good —> Passive investing = ETFs —> Oooh look an ETF which invests in REITs! —> Passive investing + property = awesome
Unfortunately, not all REIT ETFs follow a truly passive investing strategy. If you forget anything else you read in this article, remember this: It’s not just about WHAT the ETF has, it’s also about HOW it invests.
Specifically, many ETFs are actually active or semi-active funds in disguise. If you believe in the passive investing philosophy, then it’s important that you only invest in ETFs that track a market-cap weighted index. Otherwise, you’re not really passive investing. Makes sense?
So, let’s delve a little deeper into the 3 REIT ETFs available in Singapore, and see if they make sense for passive investors.
Lion Global S-REIT ETF
Our first candidate is the Lion Global S-REIT ETF, which proudly proclaims that it lets investors “invest in high-quality S-REITs screened by Morningstar, at low cost.”
It even says that it follows an index – the Morningstar Singapore REIT Yield Focus Index, which is “compiled and calculated by Morningstar Research Pte Ltd and is designed to screen for high-yielding REITs with superior quality and financial health”.
Sounds goooooood, right?
But wait – let’s take a look at their FAQs, which states:
“The Index follows Morningstar’s strategic beta methodology, which typically aims to enhance returns or minimize risks relative to a traditional market-capitalisation-weighted benchmark. Strategic beta indexes represent a middle ground on the active-to-passive spectrum. Hence, the factors used by a strategic beta index determine the inclusion and weighting of the index constituents, rather than simply based on market capitalisation. In the case of our Index, the factors used are quality, financial health and dividend yield…“
“Strategic beta” is just a fancy way of saying: “We set up a bunch of investing rules which we believe will beat the market.” In other words, this is more or less a semi-active approach to investing.
How did they come up with the criteria like “quality, financial health and dividend yield”? It’s likely that someone backtested a bunch of different criteria, found one that performed well, stood up and yelled, “Heyyyyy look I found a way to beat the market!” And then they packaged it into an index and sold it as a product.
This is fine if you believe in their active investing philosophy, though I have my doubts. For example, this study shows that 5-star funds rated by Morningstar are actually less likely to outperform compared to 1-star funds.
As every investment advisor will tell you, “past results are no indication of future performance”. It’s possible that this ETF may have found a magic formula to beat the market in the future, though based on the track record of active investing, that’s unlikely.
Phillip APAC SGX REIT ETF
Next up, we have the Philip SGX APAC Dividend Leaders REIT ETF (why do these ETFs always have impossibly long names?)
This ETF looks beyond Singapore REITs and allows investors “a convenient and easy way to gain broad exposure to the best REITs and prime real estate assets in the region”.
Unlike Lion Global, the Philip ETF is totally upfront about its non-passive methodology on its homepage:
“The ETF follows a smart beta strategy which will rank and weight the underlying REITs according to total dividends paid in the preceding 12 months, with the aim of enhancing returns above that of traditional market-cap weighted ETFs.”
In other words, this ETF invests more money into REITs that pay a higher dividend. Now, this is interesting on a couple of fronts:
First, investing in a company based on its dividends is a well-established strategy, but it isn’t passive. However, there IS some evidence that dividend stocks can outperform the market.
But just because a stock pays more dividends doesn’t necessarily make it more valuable to an investor. There are plenty of valuable stocks that don’t pay dividends or pay a low dividend. For example, Berkshire Hathaway – Warren Buffett’s company – has never paid a single dividend, yet is one of the most valuable stocks in the world. Why? Because it chooses to reinvest their earnings to expand their business, rather than to distribute it to investors as dividends. A dividend-focused strategy would miss out on stocks like this.
Third, even though dividend stocks may outperform, they also have several long periods of underperformance relative to the market. Even if you eventually come out on top, how it would feel to consistently underperform the benchmark for years? Would you realistically be able to stick to a strategy like that?
The most interesting wrinkle of the Philip SGX REIT ETF is that it weights its stocks based on the absolute dividends paid, and not on dividend yield, which is more commonly used. Why?
During a Philip info session sometime back, they revealed that they chose to weight REITs based on absolute dividends because backtest results showed that it was a superior strategy to dividend yield.
Ahhhhh, it’s our old friend The Overfitting Fallacy again. By tweaking the rules based on past results, you’ll always be able to find a strategy that performs exceptionally well in the past. But whether it continues to do well in the future is, of course, an unknown.
Random sidenote: A strategy based on weighting stocks on factors such as dividends, value, momentum etc all come under the category of “smart beta”, which was in vogue for the past couple of years (until Bitcoin came and became the Queen Bee, Mean Girls style). However, we don’t invest in something just because it’s fashionable. We invest because the philosophy is sound. Vanguard wrote an excellent paper explaining how “smart beta” strategies don’t really stand up to a boring, market-cap weighted strategy.
Nikko AM Straits Trading Asia ex-Japan REIT ETF
Finally, we turn to the Nikko AM Asia ex-Japan REIT ETF, which invests in Asian REITs outside of Japan.
According to its Fact Sheet, this ETF tracks the FTSE EPRA/NAREIT Asia ex Japan Net Total Return REIT Index. (Man, can you imagine shading a name like that in the OAS sheet of your exam paper?)
It’s embarrassingly long name aside, this is the only index out of the three that seems the most aligned with passive investing.
First, the index is calculated by FTSE, a well-established index provider (they’re the same folks behind the FTSE 100 in London, or the FTSE Straits Times Index). The ETF isn’t based off some arbitrary “index” that was backtested to get the best results. Instead, the objective of the index “represent general trends in eligible listed real estate stocks worldwide”. (Source) Translation: it exists to provide a representation of the market, regardless of how the market performed in the past.
Second, as far as I can tell, the index calculation methodology is based on a traditional market-cap weighting. I’m not an expert on index construction, but I didn’t see anything in the index rules or factsheet that indicates otherwise.
However, there’s one big annoying flaw, like waking up to discover a big pimple on your forehead: It has a horrendously high management fee of 0.5%, which seems pretty steep for a passive investing ETF.
Still, out of the 3, I would probably be the most comfortable investing with this ETF because their methodology seems the soundest and most closely aligned to passive investing.
Okay Lionel, But That’s Just What YOU Think
The folks at Lion Global and Philip aren’t going to be happy. After all, I’m comparing their ETFs against a market-cap weighted criteria, which maybe wasn’t even their intention in the first place.
That’s fair. But I’m not writing about whether these ETFs are “good” or whether they’ll make you a gazillion dollars in the future. No one can predict that. All I’m saying is: if you buy into a passive investing philosophy, then these ETFs aren’t necessarily aligned with that strategy.
Neither is this a sponsored post from Nikko AM, or something to make them seem comparably better. I call it as I see it, and maybe my analysis might be completely off, but it’s my response to the 500 questions on “Hey Lionel what do you think of REIT ETFs” that I’ve received in the past couple of months.
The big lesson here is: Don’t take the marketing schpiel at face value, especially when it comes to investment products. Always look under the hood – you’ll be surprised at what you find there.
Full disclosure: I’m not invested in any of these ETFs, though I am invested in a bunch of individual REITs. I’m wondering if I should switch though, since it’s a pain in the butt to manage them.