Subject: Re: REITs, 1970s/80s, stagflation
A possible case against:

I have invested in REITs, and income trusts more generally, only on rare occasion over the years. Only when they seem oversold, basically.

The reason for that reticence is that I like high long run total return after inflation from my portfolio, which is the only thing that really matters.

Stocks with the best long run total returns are almost invariably those with a high return on shareholders' equity and on assets, and that number not declining over time. Over VERY long periods, in fact, your rate of return on any company's stock will tend to converge on their ROE (more specifically ROIIC), no matter what your entry price was. (excluding stocks with such high leverage that they are at risk of blowing up, or miscalculations of a meaningful ROE). Almost invariably, the absolute best firms can deploy giant amounts of new capital into their business the same high rates of return.

So, the problem with income trusts is that they are required to pay out the lion's share of all their earnings. Maybe there are borrowings or fancy buy-low-sell-high activities to get around that, but the core business is being milked rather than expanded. Capital reinvestment is therefore very constrained as a general rule, so earnings do not rise much even if their ROA on the piffling amount of expansion capex were excellent. In short, they tend to have their hands so tied that they end up as cash cows: earners, but earnings not growing, so the long run total return after inflation often isn't in general a whole lot different from the coupon yield. Jam today, but same amount of jam every day. This problem is compounded by the observation that most cash cow businesses have a finite life span...you get nothing but the yield, and then at some point down the line you often don't get that either.

I believe that there is a huge population of investors who are myopically investing for income over long periods who would do VERY much better if they instead invested in the very best companies they could identify, without regard to dividends, and sold little bits of stock to fill the gap between the actual portfolio dividend yield and the desired portfolio income rate. Admittedly there are people who simply don't care about a long term rate of return as they are wealthy enough that it doesn't matter, so all power to them.

Some such folks remain unconvinced of the "sell a bit from time to time" approach because of a fear that they might have to sell some stock at low prices during a bear market. So what? Each sale is going to be tiny. If you have a portfolio large enough to live off, a bear market isn't going to change that fact. Some of those tiny sales will be at above average valuation levels, some at below average, so over time the average valuation level received is going to be pretty much the same as the average valuation level of those investments in the next XXX years, which is all you could ever expect anyway.

The excuse that it's a lot of work doesn't really fly any more, either, as there are "one click" rebalance buttons at many brokers. Every three months rebalance to (say) 99% stock and 1% cash, then withdraw the 1%. This automatically sells only the amount of stock necessary to top up the dividends received during the prior three months.

Admittedly, for some people there is a material difference in tax rates between dividends and capital gains, but (a) it's not usually that large, so (b) it's probably not a good enough reason to let the coupon tail wag the total return dog. I personally have a HUGE tax advantage in capital gains versus dividends from stocks in most countries (though not the UK), but I like to think my thoughts here apply pretty generally. Perhaps I fool myself : )

I'm not saying that there aren't some excellent income trust choices out there, nor that there aren't people whose financial needs are well met by the sector. Just food for thought about my own reason for not usually being a big fan. You asked : )

Jim