Tierra Funds’ Jamie Anderson Spotlights Latin America REIT ETF (LARE)
April 12th, 2016 by ETF Store Staff
Jamie Anderson, Managing Principal at Tierra Funds, spotlights the Tierra XP Latin America Real Estate ETF (LARE).
You can listen to our interview with Jamie Anderson by using the above media player or enjoy a full transcription of the interview below.
Nate Geraci: The ETF we’re spotlighting this week is the Tierra XP Latin America Real Estate ETF. The ticker symbol on that is L-A-R-E, and joining us via phone from just outside Philadelphia to discuss this ETF is Jamie Anderson, managing principle at Tierra Funds. Jamie, a pleasure to have you with us today.
Jamie Anderson: Thanks a lot guys. It’s great to be here.
Nate Geraci: Jamie, this is the first ETF to offer access to REITs and real estate operating companies in Latin America, and before we get into the details of this ETF, for our listeners who may be unfamiliar with REITs and real estate operating companies, can you explain what these are? What types of companies are these?
Jamie Anderson: Sure, absolutely. Basically the distinction between a real estate investment trust, R-E-I-T or REITs as you said, and a real estate operating company is a REIT by law must distribute substantially all of its pretax income to the investor. There’s some other requirements, but the major requirement is that REITs can’t engage in risky activities. That would be something along the lines of development or construction, etc. It can really only own what we call in the industry income producing stabilized properties. A good example would be a leased office building or a shopping mall that’s stabilized, or an industrial park that is leased and stabilized. In effect, a REIT is really a standard C-corp or corporation that checks the box pursuant to IRS regulations in satisfaction of the requirement to pass through this pretax income in the form of a dividend to the investor. Investors like REITs because they are generally not taking the kind of risk that you would associate with let’s say a home builder, like Lennar, or a construction company, etc. In effect, they’re designed to pass the maximum amount of pretax income to the investor, and investors like it for the income as well as the growth potential.
On the REOC side, the R-E-O-C, real estate operating company, we’re really talking about companies that engage in a broad range of real estate activities, which may include development, but it can also be a REIT-like company, like Brookfield for example or Prologis, that actually owns a lot of stabilized real estate property, be it industrial or shopping malls, but they happen to also engage in development of these real estate assets. In general, we distinguish between REITs and real estate operating companies simply to convey to the investor that with a REIT, you are getting a cleaner exposure to the income that stabilized commercial real estate offers.
Nate Geraci: Okay, so the ETF is the Tierra XP Latin America Real Estate ETF. Again, this holds REITs and real estate operating companies in several Latin American countries. Take us from there. What does the breakdown of companies looks like in this ETF? How are those companies selected? What countries are represented in the ETF?
Jamie Anderson: This is a regional product. It’s the first of its kind. We wanted to capture the broad asset class in the Latin America region for a number of different reasons, which we can get into later. The product has 56 components. There’s 56 equities. The breakdown is approximately 45% Brazil, 48% Mexico, 3% Chile, and about 1% Argentina. We expect the geographic coverage to increase as more real estate equities come to market in Peru and Columbia for example. The breakdown itself between the 56 components is about half REITs and then half non-REIT or real estate operating companies. Our selection process is actually pretty thoughtful. We’re actually real estate private equity guys who started working in the Latin America region back in the early ’90s, and what we wanted to achieve with this product was to kind of take an institutional mindset to investing in real estate and make that available to not just institutional investors through the ETF wrapper, but also to individual investors.
Our methodology is not simply market cap weighted. What we found is that if you take a market cap weighted approach, you end up with a product not dissimilar from a lot of emerging market ETF products that is heavily weighted towards a few components. We wanted to capture a balanced exposure to the region, so what we do is we take the multifactor methodology and we take market cap, dividend yield, and liquidity in the underlying shares, and we rank each of the components against the population set and then re-rank the entire population group. What we end up with is a product that is very disperse. I think the latest weights are about, the top 20 components, which is somewhere around 39% of the total components, the total 56 components, only constitute something like 56 or 57% of the weight, which is very unique in the space in terms of emerging market ETFs. You normally will find the top 10% of the components will constitute something like 50% of the weight. In other words, if you buy that product, you’re very heavily weighted towards a few of the components. While you might have exposure to smaller components, it’s really de minimis at the end of the day. The LARE, L-A-R-E is the ticker, really seeks to broaden, to diversify.
I’ll give you a great example of why this is fantastic. Yesterday there’s a Mexican home builder called GEOB, G-E-O-B is the ticker, and for some odd reason, this company shot up 67% yesterday on very much above average trading activity. Now, that’s great when it’s going up, right? You pat yourself on the back. You go out to dinner, but that kind of movement also means that you’ve got the potential for substantial downside. In the LARE, GEOB is about a 38 basis point weighting, 0.38%, so while you’ve got exposure, it’s not the kind of exposure that’s going to kill you if the stock sells off hard. Yesterday for example, you got to capture some of that GEOB movement. It actually added something like 30 basis points to the daily move on the LARE itself in total. Just to circle back really quickly, the 50% weighing of REITs in the portfolio, and that’s broken down about 50-50 between REITs in Mexico and REITs in Brazil, constitute something around 75% of the total dividend yield on the product, so right now the index is showing about a 5.2% trailing dividend yield. That’s annualized, and we’re happy to announce that about 4 weeks ago, we actually issued our first dividend, which was approximately 20.9 cents, which works out to a 3% annualized dividend yield current, which we expect to grow actually as more components start issuing dividends through the calendar year.
Jason Lank: Jamie, this is Jason Lank. In terms of exposure, it would appear that Mexico and Brazil are the largest constituents by quite a bit, and I would imagine many of our listeners have been to Mexico either for business or pleasure, but not so many to Brazil. My question is, in a recent discussion you had at ETF.com, you called Brazil’s economy funky or closed, perhaps with capital controls. Just at a high level, speak to what that means for real estate investors.
Jamie Anderson: Sure. One of the things that we find very attractive about Brazil right now is it’s been severely discounted over the last 3 years, so from a valuation standpoint, it’s really hard to not take a look at real estate assets, and frankly assets in general. So, equities in general are very cheap. Real estate in particular got very cheap. The distinction between real estate investment trusts in Brazil and in Mexico is they’re actually a new product in Mexico. They’re only 5 years old, and the legislation that governs REITs in Mexico is essentially modeled after REIT tax law in the United States. Now that being said, it’s a new industry. You’ve only got 11 listed REITs in Mexico, which we expect to probably double over the next 2 or 3 years, something like that. On the Brazil side, REITs are actually, they’ve been around for 20 years. Brazilians gravitated to the REIT model very early on because Brazil is an investment environment where yield specifically spread over cost of capital is very much paid attention to by Brazilian investors. The REIT instrument in Brazil is legally a closed end fund, so what the investor gets in Brazil is effectively a spread in the form of income rents over the cost of capital.
There’s some other things about the REIT industry in Brazil that are quite interesting. One is for example, REITs by law in Brazil can’t take on debt. You never have to worry about a REIT overleveraging itself, and then secondly, by law real estate contracts are written to include the headline CPI plus a margin in terms of their annual rental increases, so there’s a built-in hedge there with real estate rental income in Brazil that generally over time means that the investor is getting an attractive spread over inflation in Brazil. What we wanted to do by including Brazilian REITs in this was to capture that spread. The real yields in Brazil right now are about 450 basis points, which is unheard of around the world, right? While yes, inflation is high in Brazil, yes, there are some political problems, the country is heading into its third year of working through a recession, the real yields on real estate are quite attractive. For example, back in January, real estate in Brazil got down to about 0.6 times book value on an unlevered basis. I mean, that is severely discounted. You mentioned capital controls. Brazil is a country that operates with capital controls, meaning that the currency doesn’t free float. For example, you couldn’t buy the Brazilian Real outside of normal trading hours. It is very hard for individuals to, not very hard, but it’s challenging for individuals to freely, Brazilian nationals, for example, to send money abroad. Actually, it’s easier for them to receive money abroad, but it’s harder for them to send money abroad. What that means to the investor is if you invest via an instrument like the LARE, the L-A-R-E, or other Latin America ETFs, you’re already set up to receive your income freely. We’ve already gone through the process of setting up the necessary vehicles, for example the local custody accounts and the local custodian and all that stuff, to allow for the free transmission of dividends that are paid locally, as well as buying and selling of the assets.
Nate Geraci: Again, we’re visiting with Jamie Anderson, managing principle at Tierra Funds. We’re spotlighting the Tierra XP Latin America Real Estate ETF, ticker L-A-R-E. Jamie, we have a few minutes left. Where does this ETF fit in an investor’s portfolio? We’ve certainly highlighted broad U.S. REIT ETFs on the program before, but how should investors view this Latin America REIT ETF in the context of their overall portfolio?
Jamie Anderson: It’s a great complement to an emerging markets allocation for a couple of different reasons. One is it fits right in with an income objective. We expect the dividend yield to grow to approximately 5% per year, and there’s growth potential. Secondly, the LARE is highly unique because its realized volatility is right on par with the global MSCI emerging markets benchmark, which you can buy through the EEM ETF. That volatility being on par with the EEM is quite attractive because when you drill down and you look at the Latin America region itself in terms of ETF alternatives, the LARE has the lowest volatility with the exception of I think two ETFs. One is Mexico and the other is Peru, oh excuse me, Chile. If you want broad exposure through the IOF, you’re going to have a lot more volatility. If you want exposure specifically to Brazil through the ERBZ, you’re going to have more than 2 times the volatility, and again, just to circle back, while that’s great when things are going up, you have to be prepared for significant drawdowns when asset prices do sell off a little bit. We think the volatility associated with the LARE is very unique, highly complementary to anybody who wants emerging market exposure, and lastly I will say, my experience in the region in 25 years. The first rule is you want to buy assets when they’re cheap. The second rule is you want to pay a lot of attention to volatility because when things don’t work out, that’s when you get burnt.
Nate Geraci: Well, Jamie, we’ll have to leave it there. Great Spotlight. We certainly appreciate you joining us today.
Jamie Anderson: I really appreciate it guys. Have a great day.
Nate Geraci: That was Jamie Anderson, managing principle at Tierra Funds. The ETF is the Tierra XP Latin America Real Estate ETF, ticker L-A-R-E. You can learn more about this ETF by visiting Tierrafunds.com. That’s T-I-E-R-R-A-funds.com.