amREIT Lesson

My friend Dan, a veteran of the last round of amREIT wars, posted a nice piece that reminds us that humility is sometimes the most important lesson the market teaches us.

With permission, I repost it here.

Is Any One Bear Smarter than the Market? —

A long long time ago in a place far far away (that I would prefer to forget), there were two agency mREITs. The first REIT was very conservative in its projections and stated the risks to the strategy very clearly.

The second REIT told everybody that they had the market figured out and that their superior intelligence and proprietary systems would enable them to trade out of every bad position and in general allow them to trade ahead of the agency market. Specifically, they said things like the fixed rate agency market is better than the ARM market because there was less risk. They used new things like “swaptions” and “IOs”. They tended to trade a lot. They used a lot of leverage. They raised $300 million in their IPO in November 1997. Dividends were good. The stock price was high. They enjoyed a premium valuation to their peers. Life was good!

The first REIT struggled to raise $100 million in their IPO and generally traded like crap right off the bat. The first REIT was Apex Mortgage Capital. It went through hard times along with everybody else in 1998 but eventually recovered and provided very respectable returns over their first three or so years. Very bumpy but respectable at the end of that period. The first REIT is not the real moral of this story.

The real moral here is what happened to the second REIT. The second REIT was LASER Mortgage Management. They had the secret sauce. Well, at least they appeared to. However, when rates started to fall faster than anyone imagined, things began to go wrong. Very very wrong. Their hedges and other derivatives went nuclear on them. They were unable to meet their margin calls because of their highly levered volatile portfolio. The management team was thrown out in disgrace. Investors lost about half their money within one year of their IPO. The stock price dove over 70% peak to trough. A chart of their stock price during that time is attached.

I’m not saying any of this will happen again. I’m not necessarily singling out any particular company. I am certainly not hoping any of this will happen ever ever again.

What I am saying is NO ONE is smarter than the market. There never has been and never will be anyone smarter than the market over any length of time. Some say they are and most of the time those that say it the loudest have the biggest blow ups.

Will it be different this time? I personally doubt it. But that is just my opinion.

The point of this whole story is investors need to be aware of these risks and diversify their portfolios accordingly. I hate to watch the board drink too much of whatever flavor Kool-Aid is in popular at the time. If you like an aggressive storyline, go for it! I have no problem making aggressive bets. (He says as he has been horribly wrong this year.) Please, just recognize the risk when you are doing it.

End of sermon

Full Disclosure: I am long a fair amount of the agency mREIT sector with some short positions as hedges.

Noe from hh:  I might add that the group that managed Laser were with Goldman Sachs Asset Management, a fascinating bunch of people who “had it made.”


2 Responses to amREIT Lesson

  1. dreverts says:

    The performance and conference call of AGNC sounds like Laser. Do you follow that agency REIT at all? And what are the REITs you like least? Thanks for the interesting blog.

    • hhill51 says:

      AGNC runs too high a premium for me to get really enthused, so I don’t follow it. I’ve traded in and out in swing trades when it occasionally takes a swan dive.

      I did a theoretical version of this friend’s post when I first started this blog, and was looking forward to potential bargains when the Fed stopped buying. That changed when Fannie and Freddie got the green light to absorb more MBS into their portfolios.

      If the link doesn’t work, you can search check the November archive for the post called “amREIT Examples”

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