By Victor Yeung
The Hong Kong Book Fair, which takes place in July every year, is the major publishing event of Hong Kong. Last year, my first book on REITs was fortunate to have won a publishing award at the Book Fair’s Hong Kong Biennial Award.
And this year, the same publisher has invited me to write a second book focusing on REIT strategies. The Asia Pacific region has implemented REIT regimes for about 15 years, and Australia, Japan, Singapore and Hong Kong created an entrenched sector, with the top REITs in each economy having joined the top stock index of the respective markets. At this point, we believe that the economies as a whole have accrued enough experience to review the sector.
While the REIT sector as a whole have delivered respectable total return that is in-line with what investors would expect from a core or core-plus real estate program, individual REIT performance has deviated from the average trends by a significant margin. Taking Hong Kong as an example, over the last five years, the top REIT has generated a per share dividend growth of 11 percent per annum, versus an average of 6 percent of all Hong Kong REITs. Moreover, the top REIT in Hong Kong has recorded a per year total return of 20 percent since listing, versus an average of 11 percent for all Hong Kong REITs.
Thus, our book focuses on how top REIT management can outperform peers through time by adopting the appropriate operating, investing, and financing strategies. We divided the discussion into five sections that address different aspects of a REIT.
As part of the book marketing exercise, I have hosted talks at the Book Fair, industry organisations, charity groups and other private groups to discuss the book with various readers.
A book on corporate strategy would mostly draw investors’ interests to only pick the top stocks in each economy. However, under the “Prudent Investor Rule”, investors should maintain a well-diversified portfolio. Thus, a common question raised is how the focus on quality would reconcile with the desire to diversify.
When investors adopt the Prudent Investor Rule, the overarching goal is to diversify their portfolios to asset classes that have low correlation with one another. A low correlation would increase the long-term average total return and / or reduce risk (defined as total return volatility). In other words, it aims to maximise the portfolio’s risk-adjusted return.
Compared to its immediate precursor, the Prudent Investor Rule has one particular insight: No individual asset class is inherently unsuitable. A more volatile asset class, given that it has a low correlation with other asset classes, can still bring positive benefits to the overall portfolio.
This is why, over the last two decades, we have observed institutional investors around the world diversify gradually into bonds, real estate assets including REITs, and other alternatives such as private equities and commodities.
The diversification advocated by the Prudent Investor Rule, however, focuses on the low correlation between asset classes. Individual stocks or vehicles within a specific sector, however, are typically correlated with one another. This is because the vehicles are exposed to the same economic and sector fundamentals. While better management will indeed outperform other peers over the long run, the ebbs and flows of performance would also be similar.
As such, when investors overly diversified within the same asset class, investment performance does not meaningfully improve. This is because the stocks are still exposed to the sector risks. In the process, an overly diversified portfolio by definition includes weaker stocks in addition to the strongest ones, and this would lower the performance of the overall portfolio.
In conclusion, we believe that the correct investment attitude is to diversify into various asset classes and geographies. But within each asset class, investors should stay with the strongest stocks. This is why we devoted a book to discuss the corporate strategies that are available to REIT management.