Market turmoil spotlights investment truths

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The unprecedented impact that the coronavirus has had on economies and financial markets around the world in March 2020 has highlighted two very important, but often forgotten, investment truths.

Truth 1

When selecting a long-term core investment, it is important to truly understand the difference between a “basic need” and a “want-based need.” The two primary “basic needs” are food and shelter; all other needs are “want-based needs,” whose importance diminishes as financial resources become scarcer. Expenditures on, vacations, new cars, the latest iPhone, and yes even Netflix will very quickly be curtailed if it means being able to keep a roof over your family’s head and food on the table.

Truth 2

Public equity markets are often driven by fear and, during periods of heightened fear, equity losses can accelerate quickly and are not necessarily correlated to the drop-in value of the underlying assets.

For example, lets look at public vs private REITs. Stocks are typically traded on a multiple of price-to-earnings (or, in the case of public REITs, price-to-adjusted funds from operations). However, when the market is overtaken by fear, rational stock pricing methodologies give way to forced/panic selling. For instance, over the month of March, the TSX public REIT index has lost roughly 40%1 of its value as equity investors sell out in droves for various reasons. However, does anyone truly believe that the properties underlying those public REITs have suffered a permanent, decreased-in-value of 40% over the same time period?

In comparison, the value of a private REIT is based directly on the value of its underlying properties. The properties are valued on a regular basis, using traditional methods for valuing real estate, such as discounted, cash-flow analysis, replacement-cost analysis and comparable-sales analysis. So, unlike public REITs, where price/value is tied directly to its share price and is often influenced by emotions such as fear, unitholders of private REITs are, for the most part, protected from broader exchange-traded fluctuations, as their net asset value, not market sentiment, drives pricing and valuation.

1 Footnote: Bloomberg Inc.: S&P/TSX Capped REIT Index