What The Rest Of Us Can Learn From Chimera Investors' Mistakes

by: Parsimony Investment Research

Chimera Investment Corporation (NYSE:CIM) is a great case study in behaviorial finance. From both a fundamental and technical analysis perspective the stock is a complete dog (see our detailed analysis here). Yet loyal investors continue to hold on to the stock as if the company is going to miraculously turn the corner overnight.

CIM investors are an ornery lot and convincing them to sell is likely a lost cause, but hopefully the rest of us can learn from their mistakes. Below are two behavioral finance traps that CIM investors have fallen into and that all of us should strive to avoid.

Loss Aversion

"More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason." -- Philip Fisher

While we don't have quantitative proof, our guess is that at least 95% of all CIM investors are underwater. If you are only down 30%, consider yourself one of the lucky ones. CIM started losing money for investors right out of the gate in 2008 and never looked back. Finding an uglier chart than the one below would be a real challenge.

Loss aversion refers to the tendency for people to strongly prefer avoiding losses than acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains.

Investors have been shown to be more likely to sell winning stocks in an effort to "take some profits," while at the same time not wanting to accept defeat in the case of the losers.

It also doesn't help that we tend to feel the pain of a loss more strongly than we do the pleasure of a gain. It's this unwillingness to accept the pain early that might cause us to "ride losers too long" in the vain hope that they'll turn around and won't make us face the consequences of our decisions.

Gambler's Fallacy

With the gambler's fallacy, an individual erroneously believes that the onset of a certain random event is less likely to happen following an event or a series of events. This line of thinking is incorrect because past events do not change the probability that certain events will occur in the future.

With regard to CIM investors, most likely believe that the stock "can't go much lower" based on the historical trend and the current price of the stock. However, the unfortunate truth is that a stock can always go lower.

All mREITs Are Not the Same

Our bearish stance on CIM is not reflective of our view on the mREIT space in general.

Due to the structural headwinds in the U.S. economy, we think interest rates will remain low for the foreseeable future (next 12-24 months). As such, we believe REITs (particularly agency-focused REITs) offer investors an extremely compelling risk/reward profile and strong dividend yields.

Investors should focus on those managers who have a proven track record of managing their portfolio through various rate cycles. In addition, we think it is prudent to diversify mortgage REIT holdings as managers deploy different strategies within the complex.

Below is a list of agency-focused mortgage REITs:

Agency REITs with bias toward Fixed Rate Mix

  • Annaly Capital Managment (NYSE:NLY)
  • American Capital Agency (NASDAQ:AGNC)

Agency REITs with bias toward Floating Rate Mix

  • Anworth Mortgage Asset Corp. (NYSE:ANH)
  • Capstead Mortgage Corp. (NYSE:CMO)
  • Hatteras Financial Corp. (NYSE:HTS)

We are long-time holders of NLY and AGNC, which continue to be our two favorite mREITs in the space. Please see the links below for further details.

Disclosure: I am long NLY, AGNC.