Smart Beta REIT ETF: The New S&P Equal-Weight Real Estate Index
It's no secret that accredited investors, pension funds and sovereign wealth funds have more access to commercial real estate investments than the average investor.
Investor interest in this asset class has grown to the point that equity REITs and select real estate companies have essentially "outgrown" the Financials sector, which is where they currently reside.
That is why when investors wake up on September 1, 2016 they will find that these REITs along with other significant real estate companies will become part of the new GICS Real Estate Sector.
Real estate investment trusts will have been elevated to the "big leagues" where they are likely to attract more institutional investors, funds and ETFs.
Why Invest In REITs
According to NAREIT's reit.com website:
"REITs are total return investments. They typically provide high dividends plus the potential for moderate, long-term capital appreciation. Long-term total returns of REIT stocks are likely to be somewhat less than the returns of higher risk, high-growth stocks and somewhat more than the returns of lower risk bonds."
Since REITs are obligated to pay out at least 90 percent of taxable income as dividends, they are often favored by investors looking for income. REITs can also serve as a hedge against inflation due to rising rents; a feature that is not found in the vast majority of bonds.
However, the challenge for most investors remains how to gain exposure to this asset class, diversify their portfolios, and hopefully achieve higher risk adjusted returns.
S&P 500 Companies
Many investors may not realize that investing in an ETF such as the iShares S&P 500 Index ETF (NYSE: SPY), already includes a real estate component, including about 20 of the largest cap REITs, led by:
- Simon Property Group (NYSE: SPG) - $54.5 billion cap, 3.42 percent yield
- Public Storage (NYSE: PSA) - $32.3 billion cap, 3.64 percent yield
- Equity Residential (NYSE: EQR) - $26.1 billion, 3.08 percent yield
- Health Care REIT (NYSE: HCN) - $23.5 billion, 4.92 percent yield
- General Growth Properties (NYSE: GGP) - $23.5 billion, 2.56 percent yield
- Performance Potential: may help long-term performance by reducing the bias towards the largest individual companies within a particular cap-weighted strategy
- Diversification: may reduce concentration risk often found in cap-weighted indices and provide more balanced exposure across market capitalizations, sectors and other broad risk factors
- Disciplined Rebalancing: systematic reallocation from outperforming to under performing stocks and market segments may provide enhanced risk control and the opportunity to capture long-term equity market performance.
However, Financials make up ~16.2 percent of the S&P 500, and even these large REITs are overshadowed by banking giants, large insurance companies, and a well-known conglomerate run by Warren Buffett.
MSCI REIT Index (RMZ)
A more direct way for investors to get commercial real estate exposure to U.S. equity REITs is to own shares in a REIT ETF.
The Vanguard REIT Index Fund (NYSE: VNQ) is far and away the largest REIT ETF. It tracks the MSCI REIT Index, which gives investor an exposure to about two-thirds of the publicly listed U.S. equity REITs.
However, the RMZ is a market cap weighted index, so investors are gaining more exposure to the biggest REIT names, and much less to exposure to the smaller (and perhaps faster growing), REITs in the VNQ basket of REIT shares.
In essence, investors may be inadvertently doubling down on the largest market cap REITs.
Broader CRE Exposure - Equally Weighted
On June 23, McGraw Hill Financial Services (NYSE: MHFI) S&P Dow Jones Indices, announced the launch of a new real estate index.
The S&P 500 Equal Weight Real Estate Index equally weights the index constituents in the S&P 500 that are currently classified in the Global Industry Classification Standard (GICS) Real Estate Industry Group, excluding Mortgage REITs sub-industry. The Index has been licensed to Guggenheim Investments to serve as the basis for an exchanged traded fund (ETF).
Guggenheim pioneered the strategic or smart beta ETF market, with the launch of the first equal weight ETF in April, 2003: Guggenheim S&P 500 Equal Weight ETF (NYSE: RSP).
Why Is This Important?
Investopedia defines Smart beta as a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices.
According to the Guggenheim Investments web-site:
A real estate sector ETF constructed in a balanced fashion, gives investors who own market cap weighted S&P 500 Index funds or ETFs a broader exposure to the commercial real estate asset class, especially the smaller cap names.
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