Apr 2, 2020
“In the midst of every crisis, lies great opportunity”-
From an optimistic perspective, every crisis is a disguised opportunity if managed properly. From a global realistic perspective, markets investors and analysts did not view COVID pandemic as an opportunity at all. No wonder in that. Panic combined with uncertainty prevailed in global markets since COVID outbreak depicting a roller coaster performance. Despite world leaders restless efforts to comfort citizens and markets, most global indices plunged drastically to the red area. During Q1 2020, global markets depicted a declining range of around 20%-40%. Attributable to the virus widespread beside lockdown to contain the pandemic repercussions, investors were partially deprived from international diversification privileges. In essence and due to global ambiguity, some investors no longer view stocks and bonds as safe havens. If that’s the case, so what could be? During crisis periods, investors whether retail or institutional relinquish their risk appetite and seek an investment income with a steady cash flow stream besides hedging such income. In other words and under the current circumstances, could Real Estate Investment Trusts (REITS) be considered safe havens? If so, which REITS type or classes are suitable investment vehicles? Could REITS combined with dividends futures act as an effective hedging strategy? If some capital markets lack such instruments, what else can be done?
Actually, there is no concrete answer because simply no one knows what will happen next day or how this will end. At such circumstances, analyzing current facts and correlating it with what used to be a successful strategy might pave the way for potential solutions even if temporary. By definition, REITS are investment vehicles providing steady dividend income stream partially derived from the underlying rental payments. REITS could be classified into equity and mortgages. During the captioned period, REITS especially retail declined way below its intrinsic or equilibrium value in a manner similar to other stocks in the markets. What other facts we know? REITS types include but not limited to grocery retail, shopping malls, offices, apartments/mortgages, tourism specifically hotels and hospitals or medical offices and clinics. Defensive sectors include grocery and health care. By late March, the United States approved its COVID stimulus bill of around $2 Trillion announcing that more economic procedures might follow in the upcoming weeks. Hence, it could be lucrative to long some REITS stocks stemmed from the golden rule of thumb “buy low and sell high”.
Which ones? On top of the list come health care REITS and its subsectors including hospitals and medical offices. Some reports predict the continuity of around 6.8% dividend yield for health care REITS especially hospitals since revenue stream is now government guaranteed. Next on the list, grocery retail REITS especially big chains located outside shopping malls as the stimulus bill enhanced citizens purchasing power. In the upcoming few weeks, if US will deploy further COVID precautions such as partial or full lockdown, grocery retails revenue will increase even more. In the same manner, one could analyze the current importance of industrial REITS especially food and beverage producers. Shopping malls and hotels REITS come last. Some predict that these sectors could be compensated for force majeure closure and activity suspension. This resulted in Q1 dividends cancellation as announced earlier by some hotels REITS. Generally speaking, some reports speculate that less levered REITS will have better chance in outperforming its peers. Thinking about it, it is not necessary the case. It depends on the debt purpose, the REITS historical track record with its lenders and capability to negotiate or adjust its financial covenants. Some REITS survived the 2008 subprime despite their highly leveraged positions by adjusting its leverage parameters.
That being said, assuming that some REITS will continue distributing its dividends stream. How to hedge it? To partially answer the question, let’s assume derivative markets will remain capable of pricing the instrument and its underlying asset. Investors could be indifferent between dividends options or futures based on market direction assumptions. It will only make a difference depending on how confident they are regarding such assumptions to engage in an obligation or a right. Based on instrument costs especially options during uncertain periods, investors will prefer dividends futures as no upfront fees only periodical settlements. Consequently, investor will commit to a future position opposite to his REITS stock position. Choosing to be the future’s seller or buyer, this will greatly depend on the REITS sector outlook. For example, one could assume a lucrative strategy by longing hospital REITS stock and shortening its dividend future. Thus, investors ensure steady income stream besides potential capital gain from stock sale in the future. Many strategies could be deployed depending on the available instruments in the derivative markets.
Ok great, but what if some capital markets lack a broad spectrum of REITS stocks especially hospitals and local derivative instruments. Stimulus actions directed towards stock markets could be one of the solutions. For example, Central Bank of Egypt (CBE) announced a 20 Billion stock purchase program besides eliminating capital gain taxes to attract investors fund and protect retail investors’ interests. Egyptian stock exchange is more of a value market rather than growth as most stocks distribute dividends. Some reports analyzed the stimulus plan in the context of generating capital gains as an alternative for dividends in case some stocks decided to halt or postpone distribution this year. Bearing into mind, banks and financial institutions sector constitute around one third of the Egyptian equities spectrum. CBE decision to decline interest rates by 300 bps will represent a true challenge to bank’s net interest margin during 2020. Hence, bottom line will have to increase from other sources. This could be from non-recurring income like unnecessary asset stripping and sale to achieve capital gain. Others could include exploiting international diversification synergies. Hospital REITS and dividends futures arbitrage could be lucrative synergies subject to choosing an international market depicting favorable foreign currency international parity.
Finally and in my humble opinion, effective crisis management include well-timed decisions accompanied by safe landing concept. Some predicts new market dynamics and structure will emerge after the COVID crisis. Hopefully it will end well for the whole world with the least coughing and sneezing damages by preserving calmness, rationality and cooperation.
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