Tag Archives: vnq

Commercial Real Estate May Help Provide A Smoother Ride On The Road To Your Investment Goals

By Jennifer Perkins, Portfolio Manager, Principal Real Estate Investors Much hasn’t changed since the start of the year! Financial markets have recovered somewhat, but are still volatile due to geopolitical concerns, and declining oil and commodity prices have also impacted stock prices and economic growth. Meanwhile, the chase for yield in a low interest environment still continues in fixed-income markets. With an eye on the road ahead, investors are hoping for a smoother and less stressful ride to meet their investment goals. The vehicle that could get them there is commercial real estate! This is the second in a series of four blog posts highlighting some compelling reasons why we believe many investors should include private – also referred to as direct-owned – commercial real estate in their investment portfolios. While these reasons are not new, market volatility, changing market dynamics, and the potential of lower long-term return expectations raise an opportunity to reiterate the case for considering the asset class for inclusion into your portfolio. Compelling reasons to include private commercial real estate: Adds portfolio diversification. May aid in dampening volatility, potentially increasing portfolio total risk-adjusted return. A source of potential income. A possible defense against unexpected inflation. Just to recap, my last blog post discussed why private commercial real estate hasn’t historically conformed to similar whipsaw behavior the equity market was experiencing at the start of 2016, potentially allowing for private commercial real estate to add true diversification to an investment portfolio. This blog post expands upon Reason 2: Private commercial real estate may aid in dampening volatility and increases the potential for improving total portfolio returns adjusted for risk. As an investor in private commercial real estate, you are buying units of ownership of office buildings, industrial buildings, apartment buildings, retail centers, and even hotels. The buildings comprising a larger portfolio are acquired through private transactions between a willing buyer and seller, specific to individual properties. Investing in tangible properties influenced by space market fundamentals (meaning tenant demand and available supply) versus investor sentiment likely helps to dampen volatility. Unlike Real Estate Investment Trusts (REITs), private commercial real estate is not influenced by fractional ownership trading, which occurs in public markets on a public exchange. Values of private commercial real estate are also supported by in-place contractual leases, typically having meaningful duration, that help drive a steady and fairly predictable stream of income for investors of core, occupied commercial real estate. Investor return requirements on this current income, as well as total holding period returns, are driven by spreads over risk-free rates (Treasurys). Such tenant demand, available supply, contractual lease terms, and investor return requirements don’t dramatically change each and every day, thereby helping to create the potential for a return pattern with lower volatility or variability over an investment period. Over the past 10 years, the ride or return pattern experienced when investing in stocks, bonds, and private commercial real estate has been notably different (see Exhibit A). The return pattern for commercial real estate has been far smoother compared to stocks and bonds. By including an allocation to commercial real estate in an investment portfolio, the ride over the investment period could be smoother, with less turbulence. Click to enlarge Indexed to 100 as of 31st March, 2016; Source: 500 Data (Bloomberg), Investment Grade Corps (Barclays), CRE Private Equity (NFI-ODCE EW); It is not possible to invest directly in an index. Past performance does not guarantee future results. A smoother expected ride also creates the potential for increased total portfolio returns when adjusted for risk. Private commercial real estate could offer a strong income (current) return (historically 70-80% of total return) as well as the potential for appreciation (or depreciation). Exhibit B shows the effects of increased exposure to private commercial real estate has produced a slight increase to total portfolio returns, but most notably, lowered the risk, or volatility, of those returns over the 10-year time period. Therefore, the inclusion of private commercial real estate within an investment portfolio has the potential to increase total portfolio return per unit of risk. Click to enlarge Click to enlarge Click to enlarge Source: S&P 500 Data (Bloomberg), Investment Grade Corps (Barclays), CRE Private Equity (NFI-ODCE EW) In my next blog post, I will discuss Reason 3: Private Commercial Real Estate is a potential source of durable income ; another compelling reason to consider including commercial real estate as part of an investment portfolio. Stay tuned and enjoy the ride! — 1 Percentage of risk shown is the annualized standard deviation of index returns and is a measure of return volatility. 2 Annualized holding period total returns divided by standard deviation of returns over equivalent period. It is not possible to invest directly in an index. Past index performance is not indicative of future return.

Reducing Portfolio Risk With Help From Momentum Model

Reduce portfolio risk by activating momentum model. Reduce portfolio risk based on security volatility. Reduce portfolio risk through the use of stop-loss orders. Controlling portfolio risk is every bit as important as seeking portfolio return, particularly when markets are high and volatile. The following analysis takes readers through a process of controlling portfolio risk with help from a tranche momentum spreadsheet. Main Menu: We begin with the following Main Menu where the basic assumptions are laid out by the portfolio manager. In the following example we are using twelve (12) ETFs plus SHY as the cutoff security. Hence the name, Baker’s Dozen. Many of the ETFs carry low correlations with each other, an important factor to consider when identifying securities to populate a momentum oriented portfolio. In the follow screen-shot we set the number of offset portfolios to 8 and the period between offsets to two (2). What this means is that the securities are ranked multiple times (8) on different dates (separated by 2 days) based on two different look-back periods plus volatility. Using these three metrics, the ETFs are ranked each review period. My preference is to review a portfolio every 33 days so the review is rotated throughout the month. Not only are the ETFs ranked based on current data, but they are ranked two, four, six, eight, and etc. days ago so we know what the rankings looked like up to sixteen (8 x 2) days ago. The look-back periods are 60 and 100 trading days. A 20% weight is assigned to the volatility as we are looking for securities with low volatility. Only two securities are selected for each offset portfolio. This becomes more apparent in the second screen-shot so move down to that slide. (click to enlarge) Tranche Recommendations: Here we have what is called the Tranche Momentum model worksheet. This is the first of three risk reducing mechanisms. The tranche model is designed to reduce the “luck-of-trading-day” as this is a problem inherent in all back-tests as well as real portfolio management. Instead of splitting the portfolio into 50% VNQ and 50% MTUM , as the current offset recommends, we note that offset 3 recommended divisions between VNQ and TLT . Offset portfolio #5 recommended 50% allocation to SHY and 50% to VNQ. Using eight (8) portfolio offsets ends up dividing the portfolio into four securities where the percentages are based on the number of times the ETF shows up in one of the eight rankings. The worksheet permits as many as 12 portfolio offsets, but I tend to favor using eight. The following worksheet ranks the ETFs using both absolute and relative momentum principles. Readers will note that the current portfolio holds 200 shares in VTI, but the tranche momentum model recommends none as VTI is under-performing SHY, our “circuit breaker ETF.” Momentum becomes one of our risk reducing mechanisms as under-performing securities are screened out of the active portfolio. (click to enlarge) Risk Reduction Recommendations: The following worksheet combines recommendations from the above tranche data and adds a volatility factor to come up with a list of recommended ETFs. In the following slide the Maximum Trade Position Risk percentage is set to 2.0% so the total portfolio is not exposed to more than a 6% draw-down until the next review period. The still leaves individual ETFs at unacceptable risk levels which we control in the final screen-shot. Before moving to the final slide, look at the individual recommendations. Shares held in VTI and PCY are sold out of the portfolio as VTI is under-performing SHY and PCY has not shown up as a recommended ETF in any of the last 8 offset portfolios. The recommendations are to hold the following four ETFs. 75 shares of SHY – round up from 74. 300 shares of VNQ – rounded to the nearest 100 shares. 100 shares of TLT – rounded to the nearest 100 shares. 350 shares of MTUM – rounded to nearest 50 shares. (click to enlarge) Manual Risk Reduction Recommendations: For the final risk reduction activity the recommendations from the above worksheet are followed which still leaves a few ETF exposed to excess risk. The final step is to place stop-loss or Trailing Stop Loss Orders (TSLOs) on VNQ and MTUM. VTI is either sold at market or a 6% TSLO is used. While the current portfolio holds $8,000 in cash, the recommendation is to increase it to $32,500. Note that the current portfolio carries a risk of 4.8%, but if the suggested adjustments are made, the risk drops to 3.4%. (click to enlarge) With the aid of the tranche momentum spreadsheet we limit portfolio risk through absolute and relative momentum principles as these keep us out of deep bear markets. Further portfolio risk is controlled by placing stop-loss orders as a way of clamping down on excess draw-downs. Granted, these procedures work when we have an orderly market. Guarding against “flash crashes” is an entirely separate problem.

Q4 Outlook For REIT ETFs

After a strong performance last year, the real estate investment trust (REIT) space has lost ground this year, largely reflecting Fed-centric anxieties. The total return from the FTSE NAREIT All REITs Index decreased 4.52% for the year through September 30 against a 27.15% positive return in 2014. The group’s recent weak performance notwithstanding, the outlook for REITs remains favorable. The Fed uncertainty no doubt remains a dominant theme for the industry, but the central bank appears in no hurry to start the monetary policy normalization process, particularly following the recent bout of soft economic data. The “bad data”, ranging from weaker job additions in September, the decline in counts in the two ISM surveys, the dip in the Consumer Price Index (CPI) and weak manufacturing activity have raised doubts about reaching the Fed’s inflation rate target for a rate hike. Now, October seems to be almost off the table, and chances of a December hike are trending low, adding further cheer to the REIT space. No doubt, REITs’ dependence on debt for acquisitions, development and redevelopment activities make them gainers when rate remains low. Also, their dividend yield grabs investors’ attention more than yields on fixed income and money market accounts in times like this. But a low rate environment cannot be a perpetual one. While REITs (those having shorter leasing periods) with the power to adjust their rent quickly to a rate hike look quite bankable, the individual market dynamics of different asset types owned and managed by the REITs would be needed the most for the stocks to excel. After all, everything is not possible virtually, and one will eventually need “real space” for economic activities. For this special hybrid class, this is their most fundamental strength, and their ability to boost shareholders’ value through steady dividend payouts makes them all the more attractive. Dividends Still Standing Tall U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends. And as of September 30, the dividend yield of the FTSE NAREIT All REITs Index was 4.44%, while the yield of the FTSE NAREIT All Equity REITs Index was 3.97%. Clearly, the REITs continue to offer decent yields and outpaced the 2.28% dividend yield offered by the S&P 500 as of that date. Capital Access Moreover, REITs have been proactive in the capital market in recent years, leveraging the low rate environment to improve their financials. As of September 30, REITs raised over $49.0 billion in initial, debt and equity capital offerings (IPOs – $1.4 billion, Secondary Common – $20.3 billion, Secondary Preferred – $2.1 billion and Secondary Debt – $25.3 billion). This indicates the rise in investors’ confidence in this sector and their willingness to pour money into it. Exploring the Sector Through ETFs In this backdrop, we believe this is the right time to explore the sector through ETFs, so as to reap the benefits in a safer way. Considering the return prospects from dividend income and capital appreciation, we have tracked the following REIT ETFs, which could be worth considering: Vanguard REIT Index ETF (NYSEARCA: VNQ ) The fund, launched in 2004, seeks investment results by tracking the performance of the benchmark MSCI US REIT Index, which is used to gauge real estate stocks. The fund consists of 145 stocks of companies which acquire office buildings, hotels, and other real property. The top three holdings are Simon Property Group Inc. (NYSE: SPG ), Public Storage (NYSE: PSA ) and Equity Residential (NYSE: EQR ). It charges 12 basis points (bps) in fees (as of May 28, 2015). VNQ managed to attract $26.2 billion in assets under management till October 16, 2015. iShares U.S. Real Estate ETF (NYSEARCA: IYR ) Launched in 2000, IYR follows the Dow Jones U.S. Real Estate Index that measures the performance of the real estate industry of the U.S. equity market. The fund comprises 118 stocks, with its top holdings including Simon Property Group Inc., American Tower Corporation (NYSE: AMT ) and Public Storage. The fund’s expense ratio is 0.43% (as of August 31, 2015) and the 12-month trailing yield is 3.94% (as of September 30, 2015). It has around $4.4 billion in assets under management as of October 16, 2015. SPDR Dow Jones REIT ETF (NYSEARCA: RWR ) Functioning since 2001, RWR seeks investment results of the Dow Jones U.S. Select REIT Index. The fund consists of 97 stocks that have equity ownership and operate commercial real estate, with the top holdings being Simon Property Group Inc., Public Storage and Equity Residential. The fund’s expense ratio is 0.25% (as of October 19, 2015), and the dividend yield is 3.21% (as of October 15, 2015). RWR has over $3.1 billion in assets under management (as of October 16, 2015). Schwab U.S. REIT ETF (NYSEARCA: SCHH ) This fund debuted in 2011 and tracks the total return of the Dow Jones U.S. Select REIT Index. It consists of 97 stocks that own and operate commercial real estates. The top three holdings are Simon Property Group Inc., Public Storage and Equity Residential. It charges 7 bps in fees (as of October 9, 2015), while the trailing 12-month distribution yield is 2.39%. SCHH boasts $1.7 billion in assets under management (as of October 16, 2015). First Trust S&P REIT Index ETF (NYSEARCA: FRI ) Launched in May 2007, FRI is an ETF that seeks investment results of the S&P United States REIT Index, which gauges the U.S. REIT market and retains consistency, depicting the overall market composition. The fund comprises 157 stocks, with the top holdings being Simon Property Group Inc., Public Storage and Equity Residential. The fund’s net expense ratio is 0.50% (as of May 1, 2015) and the 12-month distribution rate is 2.73% (as of September 30, 2015). FRI has about $206.5 million in net assets under management (as of October 16, 2015). Original Post