Path to prosperity

Measures

1. Extension of the Project Completion Period by 6 months for residential, commercial and industrial development projects 
2. Extension of the commencement and completion of residential development and sale of housing units in residential developments relating to the remission of the ABSD by 6 months
3. Extension of the PCP and/or disposal period by up to a total of 6 months for residential development projects under the QC regime for foreign housing developers
4. Extension of time by 6 months for the sale of 1st residential property relating to the ABSD remission for the 2nd residential property for a Singaporean married couple (at least 1 Singapore Citizen)

HDB Resale Transactions (Source: HDB)

Pipeline supply of residential units (Source: URA)

URA Property Price Index (Source: 99.co)

The age-old debate between active and passive investing hinges on the efficient market hypothesis (EMH); this is where asset prices reflect all information and consistent outperformance on a risk-adjusted basis (alpha) is not possible. This is then split into 3 main forms of EMH

1. Weak form - This suggests that stock prices reflect past pricing data and that technical analysis cannot be used to generate consistent risk-adjusted outperformance. On the other hand, fundamental analysis could be used to find under or overvalued stocks. 
2. Semi-strong form - This suggests that all public information is reflected in a stock's price and neither technical nor fundamental analysis can be used to achieve alpha. Private information can be used to generate alpha. 
3. Strong form - This suggests that all information (public and private) is reflected in a stock's current price and there is no way to achieve returns greater than the market return.

Along the spectrum of the types of market efficiencies, I probably lie somewhere between weak and semi-strong form. In general, I believe that prices reflect most of the public information especially for larger more liquid stocks but there are some exceptions I would like to highlight below.

1. Lack of analyst coverage
Companies which are less well-covered by stock analysts could be mispriced in the market as a result of the lack of public and private information flowing through to the market price. The lack of analyst interest could stem from the low trading volume, implying a lower amount of trading commissions can be earned from transactions in the stock. Even as such companies release information, there may be insufficient market participants and fund flows to correctly price the stock.

2. Lack of liquidity
The gradual shift towards passive investing could also lead to a bifurcation between index-linked/ETF-tracked stocks and smaller, less-liquid stocks that fall through the cracks. Such small-mid cap stocks could potentially be mispriced as a result of the low liquidity. The reason for this exception is also quite similar to the one above where the lack of liquidity prevents the stock from finding an 'equilibrium'/correct market price.

3. Imperfect flow of information
For developing market economies where disclosure standards are less stringent compared to the US, the ability to extract alpha from equity investments highly depends on the amount of research and work put in by the fund manager. An example could be channel checks, where the fund manager speaks directly to the management of companies they invest in and also their industry peers. On the SGX, one example would be Eagle Hospitality Trust, which did not disclose certain interested party transactions as a result of the lack of such requirements.

MAS and SGX were aware of such issues plaguing small-mid cap firms and hence launched the Grant for Equity Markets Singapore (GEMS) to help enhance coverage of small-mid cap stocks as well as to help defray some of the listing costs. It was hoped that more research coverage would lead to greater awareness about certain stocks and in turn lead to greater trading liquidity and hence a more efficient market.

For investors, the inefficiencies could imply that there are opportunities for alpha generation, especially for smaller and less liquid stocks. However, due to the nature of such stocks, there may also be less information available publicly hence a high level of due diligence is required before taking the plunge. As the saying goes, high risk high return.

Some stocks I am keeping track of are: Uni-Asia, Centurion, BRC, HRNet, PropNex, Fuyu

Top 10 STI Constituents (Source: FTSE Russell Factsheet 31 Mar 2020)

Why this matters?
As many strategies (ETFs, Index-tracking funds, structured products) are benchmarked against it, when a constituent stock is replaced, index funds that track the STI would have to sell off their holdings in the stock that is removed and buy the stock that is added. This flow of funds can depress the stock price for the removed stock and vice versa for the added stock.

The most recent example of this happened in Dec19 when Mapletree Logistics Trust (MLT) replaced Golden Agri (GGR) in the STI on 23rd Dec 2019; this was announced on 5th Dec 2019. The day before the announcement, MLT closed at $1.70. 2 months later in mid-Feb, MLT was up ~19% to $2.02.

STI Dec 2019 change (Source: FTSE Russell)

How the review is done
According to the STI ground rules (link here), the STI constituent review will happen quarterly in Mar/Jun/Sep/Dec. The review will be based on data from the close of business on the Monday 4 weeks prior to the review effective date. This review effective date will be after the close of business on the third Friday of the month.

To be inserted into the STI at the quarterly review, a company has to be at least 20th position by full market cap. For deletion, it has to fall to 41st position or below by full market cap. A company can also be removed from the STI if it is subject to a takeover and will be delisted. In this scenario, the vacancy will be filled by the highest ranking security by full market cap in the Reserve List. The reserve list is currently made up of Mapletree Industrial Trust, Suntec REIT, Keppel REIT, Mapletree North Asia Commercial Trust and NetLink NBN Trust.

Potential additions/deletions?
In 2019, 2 REITs, Mapletree Commercial Trust and Mapletree Logistics Trust were added in Sep and Dec respectively. This was a function of the REIT bull-run in 2019 and also aided by the fading fortunes of Hutchison Port Holdings Trust and Golden Agri, which were replaced. The reserve list currently has 5 REIT/BTs which could potentially be added. Based on a quick check, none of the 5 reserve list stocks are within the top 20. However, it is interesting to note that all 5 are ranked higher than SPH (ranked 42nd) and Sembcorp Industries (ranked 38th). Additionally, as SPH ranks 42nd, it would qualify for deletion if the cut off date was today!

According to FTSE Russell, where a greater number of companies qualify to be deleted (SPH in this case) than those qualifying to be inserted (none in this case), the securities of the highest ranking companies that are presently not included in the index will be inserted to match the number of companies being deleted at the quarterly review. In effect, this could mean that Mapletree Industrial Trust could be included despite not having met the criteria of being the top 20 market cap stock; MINT was only ranked 25th.

Ranking of top 50 SGX stocks by market cap

Another deletion on the cards would be that of Capitaland Commercial Trust (CCT), which will be merged with Capitaland Mall Trust (CMT). According to reports, the expected completion is the merger is mid2020; assuming some delays to 3Q2020, this would be in time for the Sep20 review. According to FTSE, when one constituent in the STI is absorbed by another, the vacancy created will be filled by selected the highest-ranking security by full market cap in the reserve list. After MINT potentially goes off the Reserve List in Jun20, the next in line would be Keppel DC REIT!

Conclusion
Jun20 - SPH (out), MINT (in)
Sep20 - CCT (out), KDCREIT (in)
The covid-19 induced market turmoil looks to be throwing up some interesting index changes. I am also unsure whether there will be any support from the SPH shareholders to ensure they remain in the index. Weirdly enough, SPH is the creator of the STI index together with SGX and FTSE Russell. On the other side, this further reinforces the positive sentiment surrounding the 2 data-centre linked REITs.

Work done
For my team, we were working on the standard 4-day shift cycle:

What the Covid-19 test looks like (Source: MediVisuals)

Earlier today, PM Lee announced that Singapore's circuit breaker measures will be extended by 1 month until 1 June 2020. The measures were supposed to end on 4 May but due to the increasing number of unlinked cases in the community, these measures were extended and will also be tightened to reduce the number of people going out.

In anticipation of this, it appears that the majority of S-REITs retraced gains from last week. REITs with retail exposure will continue to be the most affected as seen from the declines of CMT, MCT and Suntec. With even lower sales volumes, it would be interesting to see how many more essential businesses will decide to voluntarily close to keep costs down.

S-REIT closing prices as at 21 Apr 2020 (Source: SGX)

As the closures drag on, the follow-on impact to the other REIT sectors is also likely to be larger than initially expected. Both office and industrial landlords are likely to experience negative rental reversions and even declines in occupancy if businesses downsize.

During this extended period of uncertainty, investors could see a flight to safety with long WALEs (weighted average lease to expiry) and strong balance sheets being favoured. To this end, we already see Keppel DC REIT outperforming with a WALE of 8.3 years and 32% gearing. The market has rewarded KDCREIT by letting it trade at >2.0x P/B. While this could indicate limited near-term upside, I think investors are more focused on downside protection for now and could continue to support KDCREIT's share price.

While KDCREIT has not disclosed its tenant list, I understand that this includes the likes of large hyperscale cloud players like Amazon Web Services. During this period, I do not foresee any trouble for such tenants in paying rents or requiring substantial rental support from the REIT. For now, KDCREIT continues to tick the right boxes as a sustainable real estate asset class.

KDCREIT 1Q20 outlook slide (Source: KDCREIT announcement)

In related news, KDCREIT's sponsor announced a partnership to study the feasibility of a floating data centre park. If this takes off, this could be an interesting development as the permits for new data centres in Singapore have been drying up. Looking forward to this potentially becoming a new pipeline ROFR (right of first refusal) asset for the REIT and seeing how the market reacts to this new sub-asset class.

Summary of new measures introduced

Key impact on REITs
1. Greater flexibility - Before the new measures last evening, there were concerns being raised (especially amongst retail REITs) that government measures that allowed tenants to defer rents were prejudicial against landlords. Cashflow from rents would have been severely affected while obligations like loans and fixed costs would still have to be met. As tax transparency was calculated based on accounting (accrual) profit rather than actual cashflow, deferred rents would still be accounted for as revenue and REITs would have had to pay out more cash than they had collected. This would have led to a cash deficit in the short run.

The extension in the timeline would allow REITs to defer some distributions until cash was actually collected so that they can conserve cash in the short run to meet more urgent fixed obligations as they ride out the Covid-19 storm. For investors, while short-term distributions could be affected when REITs reduce their payout ratios, the flexibility accorded to REITs would allow them to make better financial decisions for longer-term viability (ie. no need to take on extra debt or dilutive equity fund raisings to pay distributions).

2. More buffer - Due to the impending Covid-19 induced recession, there were fears that asset valuation declines would lead to some REITs breaching the 45% gearing limit. Recall that the gearing is calculated by taking debt over asset value (property valuation makes up almost all of the REITs' asset value). Property valuations are likely to take some hit as income generated from rents could be impacted, especially for retail assets if this pandemic quickens the transition away from brick-and-motar stores. Based on the table below from RHB Research, most REITs would require a >20% decline in asset values before the 50% gearing limit is breached. The 2 closest REITs to breaching the gearing limits are ESR and OUECT.

The higher gearing limit would help to remove the uncertainty over breaching the gearing limit as a result of declining asset values. For some REITs, this also provides it with additional firepower to make opportunistic accretive acquisitions during this period when asset values could be depressed. Examples could be SPHREIT, KDCREIT and FCT which have (and historically had) very low gearing ratios (~30% or less). In particular, FCT has a ready-made pipeline from the PGIM portfolio it currently has a minority stake in with its parent company.

S-REIT debt profiles (Source: RHB Securities Research)

3. Lower cost of capital - As REITs are a dividend paying hybrid of equity and fixed income, valuations tend to be focused on yield and the DDM (dividend discount model). The higher gearing limit could also lead more REITs to have a slight uptick in their proportion of debt-equity funding. As the cost of debt is typically cheaper than the cost of equity (especially now that REIT share prices have been decimated), the higher debt proportion could result in a lower weighted average cost of capital (WACC). This could potentially increase REIT valuations.

Apart from the valuation perspective, a lower cost of capital would allow public listed S-REITs to compete more effectively with private funds which are not subject to such limits. Previously, a REIT may have been outbid by private funds which can make acquisitions accretive to themselves (private funds) as they have a lower cost of capital.

Overall I think most would agree this is a positive step by the 3 government bodies to give some breathing space to S-REITs. The market was also in strong agreement with a number of REITs being up >5% today. While the measures provide S-REITs with additional funding buffers, I believe the key would be to see what REIT managers do with them. At the end of the day, markets would still accord a premium to managers (lower yield spreads, higher P/B) that have better capital management strategies and come out of this Covid-19 situation stronger.

S-REIT prices sorted by trading value (Source: SGX)