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U.S. investing site Of Dollars and Data did a fascinating experiment in an effort to uncover actual financial experts, as opposed to charlatans, in the quickest way possible.

A contest was designed as a “Financial Turing Test.” The original Turing Test was a series of questions to an unknown entity that would determine whether it was human or machine. The Financial Turing Test proposed by Of Dollars and Data was a search for one question that would tell an investor whether the person they were talking to was an actual market expert or not.

There were over 600 suggestions for the perfect question submitted. They ranged from “Do you own bitcoin?’ to “Where do you think the market’s headed?” to “what is your net worth?”

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The experiment’s designer, Nick Maggiulli, chose a question that attempt to nullify the effects of luck in investing, “What would you do to have the highest probability of becoming financially secure regardless of your background?”

My question would be “Do low price to earnings stocks outperform?” because it requires a nuanced, two-part answer.

The first correct answer to the question is ‘depends on the sector’. In an exhaustive research report published annually, Merrill Lynch quantitative strategist Savita Subramanian analyzes 25 years of market history to uncover which valuation method works best in each sector.

Low price to earnings generates outperformance in some industries – banks, insurance and media – while other measures like price to free cash flow, enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization) work much better in others.

The second, more important, answer to my question concerns time horizon. Ms. Subramanian’s work indicates that over a ten-year investment period, low valuations are by far the most important determinant of investment returns.

Crucially, however, the analyst found very little correlation between valuations and nine-year investment returns. Low valuations are extremely important, but investors have to hold the cheaply-acquired stocks for an entire decade to reap the benefits.

At a basic level, my “Financial Turing Test’ submission challenges an alleged financial expert’s grasp of the limitations of stock selection methodology and recognition that successful investing occurs over longer periods.

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-- Scott Barlow, Globe and Mail market strategist

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Stocks to ponder

Sienna Senior Living Inc. Year-to-date, this dividend stock has delivered solid gains to its shareholders, rising 18 per cent. However, since Aug. 1, the stock price has dropped nearly 8 per cent after management reduced its earnings outlook. Given the pullback in the share price, the stock neared oversold territory last week with a relative strength reading of 35. Jennifer Dowty profiles the stock

The Rundown

The TSX is almost at a record high - but this time, there’s a curious twist

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Canada’s main stock market index is approaching a record high. In a curious twist, that rally is being driven by simmering concerns about a weaker global economy. But can Canadian stocks power ahead if the economic outlook brightens? David Berman takes a look.

Canada’s TSX 60 to gain a gold miner, lose an energy player

The index of Canada’s biggest stocks has welcomed a gold company and said goodbye to an energy player, but the changes that weren’t made are even more notable. David Milstead reports

Not all rate-reset preferred shares get hammered by falling interest rates

The most common type of preferred share is developing a reputation for being a liability when interest rates are falling. Don’t entirely write off rate-reset preferreds in a falling rate world, though. A small slice of the rate-reset market offers a minimum dividend, a sweetener that helps these shares weather rate declines better than other rate-reset shares. Rob Carrick reports

How to invest in this period of both risk and uncertainty

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David Rosenberg on why U.S. Treasuries may still be the best bet for investors right now.

Others (for subscribers)

Wednesday’s analyst upgrades and downgrades

Wednesday’s Insider Report: CEO invests over $1-million in this dividend stock

Tuesday’s Insider Report: Director invests over $34-million in this stock yielding 5.8%

How RBC’s head of global fixed income is navigating the bond market in today’s low interest rate environment

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How negative interest rates offer an opportunity for investors in bank stocks

Ten mining stocks to watch in Canada’s materials sector

Others (for everyone)

U.S. corporate bond, IPO markets heat up as recession fears persist

‘We need to talk about Donald’ - The elephant in crude oil’s uncertain world

Globe Advisor

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Long-term outlook for emerging markets remains strong

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Ask Globe Investor

Question: I hold the iShares S&P/TSX Capped REIT Index ETF (XRE) and it has been doing well. I would like to increase my exposure to Canadian REITs. Should I buy more XRE or diversify and purchase another ETF such as VRE or ZRE?

Answer: Real estate investment trusts own income-producing assets such as shopping centres, offices, industrial buildings, apartments or – in many cases – a mix of property types. The beauty of REIT ETFs is that they give you exposure to a basket of REITs and a diverse portfolio of properties across the country with a single investment. And you’ll never have to bang on anyone’s door to collect the rent – the “cheques” just land in your brokerage account every month.

Assuming you don’t already have ample REIT exposure – I usually aim for about 10 per cent to 15 per cent of my equity portfolio – diversifying your REIT holdings is probably a good call in your case.

Why not just add more to your existing XRE position? Well, XRE’s top four holdings – Canadian Apartment Properties REIT (CAR.UN), RioCan REIT (REI.UN), H&R REIT (HR.UN) and Allied Properties REIT (AP.UN) – account for about 48 per cent of the fund’s assets. That’s a hefty weighting in just four names.

Similarly, Vanguard’s FTSE Canadian Capped REIT Index ETF (VRE) has roughly a 43-per-cent weighting in the same four REITs, so VRE wouldn’t be my first choice if you’re looking to diversify. Even though XRE and VRE track different indexes, both benchmarks weight their constituents based on market capitalization, which explains the overlap.

The good news is that not all REIT ETFs use market-cap weighting. The BMO Equal Weight REITs Index ETF (ZRE) follows – you guessed it – an equal-weight methodology that prevents any REIT from having outsized influence, for good or bad, over the fund’s returns. As of Sept. 5, ZRE’s largest holding was Summit Industrial Income REIT (SMU.UN), at about 5 per cent, and the smallest was SmartCentres REIT (SRU.UN), at about 4 per cent. Given its weighting system, ZRE might be a good choice if your goal is to diversify.

In other respects, XRE and ZRE are similar. Both have a management expense ratio of 0.61 per cent and yield about 4.1 per cent, based on cash distributions paid over the past 12 months. As for VRE, it has a lower MER of 0.39 per cent (which is a good thing), but its yield is also lower, at 3.3 per cent (which is a drawback if you are primarily seeking income). VRE’s lower yield reflects the inclusion of several real estate corporations, which do not use a REIT structure and generally pay out less cash than REITs.

Still another option is the CI First Asset Canadian REIT ETF (RIT). Unlike the other ETFs discussed here, RIT does not track a REIT index but is actively managed. This is reflected in RIT’s higher MER of 0.9 per cent. Is the extra cost for active management worth it? Well, RIT’s annualized total return (assuming all distributions were reinvested) for the three years to Aug. 31 was about 12.1 per cent, which slightly trailed ZRE’s total return of 13.4 per cent over the same period. Both of these ETFs topped XRE’s annualized three-year total return of 11.4 per cent and VRE’s return of about 10.1 per cent. These are backward-looking numbers, and there are no guarantees that RIT and ZRE will continue to outperform.

Finally, depending on your comfort level and how much capital you have available, you may wish to consider owning individual REITs instead of REIT ETFs. You’ll pay brokerage commissions on your initial (and subsequent) purchases, but you will eliminate the MER that REIT ETFs charge on a continuing basis. Buying individual securities is not for everyone, but it will slash your costs and could improve your returns. The MERs on REIT ETFs aren’t egregious, but they’re significantly higher than the MERs on broad index-tracking ETFs.

All of that said, the REIT ETFs discussed here all give you diversified exposure to real estate at a reasonable cost. More important than the subtle differences in MERs, yields and holdings of each ETF is the behaviour of the person who owns them. Real estate is a cyclical business, and it has benefited in recent years from a strong tailwind of falling interest rates. If interest rates rise, the economy stumbles or REITs have difficulty accessing capital, REIT unit prices will likely suffer in the short run. But real estate has been a great long-term investment, and holding it through good times and bad – and collecting the attractive distributions that REITs offer – is probably the best strategy. So, if you’re going to add to your REIT position, keep that in mind.

--John Heinzl

Do you have a question for Globe Investor? Send it our way via this form. Questions and answers will be edited for length.

What’s up in the days ahead

A growing number of people are beginning to think about what was once considered unthinkable – the prospect of zero, or even negative, interest rates in the world’s largest economy. But despite Donald Trump’s tweets, the case for further falls in interest rates appears to be fading. Ian McGugan will report.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff

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