US-listed Real Estate Funds: Chronic Underperformance

US-listed REITs account for nearly $1 trillion market cap out of the approximate $2 trillion global real estate estate sector. Not surprisingly, US-listed real estate funds, including active mutuals and exchange traded funds (ETFs), invest heavily in large cap domestic REITs. Listed funds manage roughly $170 billion of assets under management (AUM) across 190 products, however the vast majority of funds under performed the Morningstar Global Real Estate Index. Indeed, the Vanguard REIT ETF itself under performed not only the Morningstar Global Real Estate benchmark but also the S&P500 and displays higher volatility year-to-date, which suggests interest rate concerns are the over riding factor at play in the sector.

US-listed real estate funds are an interesting case study in both chronic under performance across the space and over concentration of AUM in popular products. The Vanguard REIT ETF holds 20% of all AUM and is nearly 7x larger than the next largest product. For the year-to-date period as of 10/14/2016, 72% of all listed products failed to match the returns of the Vanguard REIT ETF and a full 90% under performed the broad Morningstar Global Real Estate Index. We ran the same analysis over a five year period and the ratio of under performers mirrored the year-to-date results.


Our research suggests there a several factors at play here. First, US-listed funds tend to own the same basket of large cap REITs so other than cost, the typical real estate fund tracks the largest, most cost effective funds. Second, few US managers venture outside of large cap developed markets where non-correlated returns are available. Third, the concentration of AUM in a single product likely skews performance in the widely-held REITs, and fourth, US REITs are fully-valued and have been a drag on returns this year, as measured by higher volatility, beta and correlation versus the S&P500; that what worked well over the last few years, simply isn’t the case now. For example, the Vanguard REIT ETF alone shed $4 billion in market cap since the end of July (-11%) which likely impacted performance of other funds as well. And this shows up as well when we look at beta across the US-listed real estate fund space.

Few realize that US real estate funds are no longer non-correlated sources of alpha. In fact, over 80% of funds exhibit beta >1 versus the S&P500. The Vanguard REIT ETF showed a 1.1x beta versus the S&P500 year-to-date, realized volatility of 16.5% versus the S&P500’s volatility of 14%, and it under performed the S&P500 by approximately 200bps. It turns out that a 100bps in additional yield actually cost the investor 1000bps in alpha this year alone.


So what is going on here? Is this temporary or a harbinger of worse things to come? Real estate traditionally was a diversifying factor in a portfolio and that clearly is not the case for now. We believe, like fixed income, US REITs are already in a bear market but not the traditional bear market where losses occur over a relatively short period of time, asset prices reset and new capital re-enters. This bear is going to take a while, maybe two to three years, or longer. For the US REIT investor, it may end up feeling like a slow boil, marked by chronic under performance for the large cap, widely-held companies.

On the interest rate front, we think US REITs are trading in lockstep with fixed income. Large cap US REITs offer very limited appreciation potential as a result of oversupply and slow growth, trade at historically high valuations and have become quite crowded. In analyzing the real estate fund segment, the problem with US REITs becomes even clearer – extracting alpha from a crowded, highly correlated basket with above average volatility almost guarantees under performance. So, the question is: why aren’t managers diversifying into non-correlated, growth markets like Latin America?

By simply adding an allocation to properly diversified LatAm real estate this year, the average US manager could have improved performance substantially and reduced its risk profile at the same time. However, if the manager wants to move the needle, the allocation must be material. Some managers appear to have approached Latin America with a check-the-box mentality, wherein they add one or two names at a de minimis weight. Token allocations in the handful of widely-held Latin America names is not going to have an impact. To do so, the US manager will have to allocate at least five percent and ideally 10 percent but do so over a broad regional basket of real estate equities which presents a conundrum: many names are too small to be added individually. The solution? We believe a regionally diversified vehicle that offers exposure across the market cap structure without having to engage in single stock selection but offers compelling risk-adjusted exposure is a pretty good solution.


Higher Yields, Lower Correlations With This Real Estate ETF

Higher Yields, Lower Correlations With This Real Estate ETF

Higher Yields, Lower Correlations With This Real Estate ETF
Run, Don’t Walk To This Latin America ETF
Avoid Fed Shenanigans With This Real Estate ETF

In addition to the tidy dividends and often high-by-comparison yields, one of the primary selling points with real estate investment trusts (REITs) and the corresponding exchange-traded funds is the perception this asset class, often viewed as alternative, is not highly correlated to traditional equity indexes.

However, data suggest that many big-name U.S. REIT ETFs are highly correlated to the S&P 500 and, in many cases, have roughly the same beta as the benchmark U.S. equity index. Some major U.S. REIT are as much as 80 percent correlated to the S&P 500.

Almost A Year Old

Of course, elevated correlations to U.S. stocks are not a concern for Tierra XP Latin America Real Estate ETF NYSELARE, which allocates about 96 percent of its combined weight to Brazilian and Mexican real estate names.

LARE debuted in December and tracks the Solactive Latin America Real Estate Index.

“The Solactive Latin America Real Estate Index screens for all listed equities with primary listings in the Latin America region and which derive substantially most of their income from real estate and real estate services. The Index then uses dividend yield, market capitalization and liquidity in the underlying shares to determine weights. The Index is rebalanced quarterly,” according to Tierra Funds.

Not only is LARE not highly correlated to traditional equity benchmarks, but its holdings usually sport yields well in excess of those found on comparable U.S. REITs.

Setting Itself Apart

“Latin America real estate companies offer some of the highest dividend yields in the world with Brazil REITs paying around 10 percent and Mexican REITs offering yields of more than 6 percent,” according to LARE Index.

That at a time when yields of 3 percent to 4 percent are considered impressive for U.S. real estate strategies. For those that insist on labeling LARE as a Brazil ETF, notable are the facts that as of August 9, LARE is showing volatility that is about half that of the largest Brazil ETF and a dividend yield that is more than 340 basis points higher. Speaking of yield, LARE’s dividend yield is 5.58 percent, which is far superior to what investors will find on standard U.S. REIT ETFs.

LARE’s underlying index’s “low volatility and low correlation suggest it may be an attractive source of alpha for a broad Emerging Markets strategy and a risk mitigator for a Latin America allocation. For example, LAREPR’s realized volatility is less than half versus the MSCI Brazil Index and 20 percent lower volatility against the MSCI Mexico Index,” according to Tierra Funds.

On Brazil Valuations, A Reality Check

As long-mostly investors, we tend to be (a) optimistic about the future and (b) early at times. Full disclosure: we started to get really excited about EM last Fall which is why we decided to go live with the LARE Index and license it out to the first US-listed product offering access to the LatAm real estate asset class. Our 20+ years’ experience taught us that when EM valuations approach extremely oversold conditions, the first movers tend to be bond and real estate investors. That is exactly what we saw in the Fall: EM sovereign bonds rallied and FX correlations diverged. The USD negative correlation trade crossed an inflection point.

The late January swoon presented investors with a glaringly obvious entry point. Brazil REITs, for example, were trading at close to half of tangible book value. Brazil assets overall were trading at single digit P/E and the proverbial taxi driver was busy shorting everything EM. But old ideas die hard. After a massive rally in the 2nd quarter, we found ourselves, again, facing deep skepticism from even sophisticated institutional investors about Brazil’s prospects. The same crowd that doubted the oversold conditions a year ago simply swapped one wrong view for another, just because.

What we want to point out here is that despite an exceptional rally and continuation of the same rally into the Fall this year, Brazil remains quite attractive from a valuation standpoint. We estimate that about 60% of the Brazil rally YTD is attributable to FX, which suggests there is room to run.

Brazil becomes even more compelling when compared against the S&P500. By almost every metric, Brazil is attractive and offers a decent cushion should either macroeconomic or political conditions deteriorate. We believe Brazil is about halfway through the normalization process, however, this time is different for a couple reasons:

First, the current phase will be much longer than previous cycles. Given global slow growth and unknowns related to the post-commodity cycle, we just don’t know how Brazil will fare in its transition to a consumer-driven economy. Right now, it looks like the Temer government is steering policy successfully. That said, investors in broad equities need to accept the notion that alpha will become more elusive as Brazil volatility is unlikely to fall much and overall returns will come down. For this reason, we really like real estate which inherently is low volatility and low correlation. Real estate also pays the investor to wait. Note: historically high Brazil yields are gone for the time but not for real estate which offers unleveraged yields of around 10%.

Second, while we know what Brazil growth looks like when you strip out China demand for commodities, we really don’t know what a consumer-driven long term growth rate will be? Will it look more like Mexico or better or worse? We don’t know.

Third, we know the central bank is very close to cutting rates and we also know they can cut rates a lot (we think 200bps to 300bps over the next 12 to 18 months). What we don’t know is the pace of cuts nor how the central bank would react if above average inflation remains sticky? Will they adopt the Yellen view of letting it run hotter for longer or will historical experience with hyperinflation cause the central bank to act hawkish should CPI remain high? We don’t know.

What we do know is developed markets assets are not cheap. Everywhere we look we see yields converging across the private-public spectrum, so while growth may still be a projection in Brazil, at least there is valuation on both an absolute and relative basis. You may not like it but it’s a clear reason to have at least some exposure.


Barrons – Aug 2016

Reprinted from Barron’s

3 Brazil Headlines: Temer Fingered, Petrobras Sales, REITs Attractive?

The iShares MSCI Brazil Capped exchange-traded fund (EWZ) is up nearly 2% today, pushing the fund’s weekly performance well ahead of the 1% decline in the iShares MSCI Emerging Markets ETF (EEM).

Some of the headlines coming from Brazil:

Brazil’s interim President Michel Temer denied allegations that he had a part in a graft scheme at state oil company Petroleo Brasileiro or Petrobras (PBR), the country’s biggest ever corruption scandal. Petrobras shares are up more than 2% this week. The Wall Street Journal in a story today writes:

” … Temer denied the claims made in plea-bargain testimony by Sergio Machado, former head of Petrobras Transporte, or Transpetro, a fuel-transportation and logistics subsidiary. Mr. Machado has testified that in 2012 he organized, at Mr. Temer’s request, a donation of 1.5 million reais (about $432,000) from a construction firm to Mr. Temer’s political party, in exchange for Transpetro contracts. Mr. Temer dismissed the accusations as “frivolousness”… “irresponsible lies” …But the sweeping charges laid out by Mr. Machado may not be quickly or easily dispelled. They implicate some two-dozen politicians from seven different political parties …”

Meanwhile analysts project that Brazil officials will impeach President Dilma Rousseff by mid-August.

Petrobras, Brazil’s state-run oil company, received bids for a stake in its fuels-retailing unit BR Distribuidora in recent days, chief executive Pedro Parente said in his first television interview since taking the helm June 1, according to Reuters. He is trying to speed up the sale of assets — $14 billion in hoped-for divestments of oilfields, processing and distribution systems, power plants and other operations — to cut its $130 billion debt. See the Reuters story, Petrobras received bids for unit in recent days, CEO

Tierra Funds Jamie Anderson said in a prepared release that the U.S. Federal Reserve’s decision to delay an increase in interest rates provides “much needed breathing room” for emerging markets, especially China and Brazil. Tierra is  promoting a so-far small and illiquidfund it launched in December, the Tierra XP Latin America Real Estate ETF (LARE), which is focused on Brazil and Mexico real estate. Anderson the writes:

“Brazil’s central bank released its minutes Wednesday from its latest policy meeting and noted, among other things, that rate cuts will be on hold a little bit longer as inflation is still well above target levels. That said, year on year CPI has fallen from roughly 10.5% to 9.6% and the central bank believes we should see moderately lower CPI as we get into the summer season. We continue to view risk-adjusted yields from Brazil REITs as quite attractive and have noted above-average trading volume on many non-REIT real estate equities lately, which to us suggests that investors are positioning for what many expect to be a constructive second half of the year.”

The Tierra real estate ETF is up 16% this year, in line with the much larger and more diversified iShares Latin America 40 ETF (ILF).

Forbes – Feb 2016

Why Latin America Is The New Hot Spot For Investors

Investors who feel they’ve been booted out of the U.S. real estate market (and the rest of the developed world for that matter) may want to consider doing the cha cha cha in Latin America. Exchange-traded fund industry newcomer Tierra Funds believes Latin America is the new hot spot for real estate investors.

Tierra Funds rolled out the first ETF investing solely in real estate investment trusts (REITs) and real estate operating companies (REOCs) in that region. Tierra XP Latin America Real Estate ETF (LARE) debuted in December with about $2 million in assets.


James Anderson is the managing principal of Tierra Funds based in Devon, Penn. He explains why real estate investors should venture to Latin America.

Key Growth Areas

Ho: Why did you launch this ETF?

Anderson: A few years ago we predicted that global private equity would be supplanted by local pension capital as the primary source of financing for both real estate development and long-term investment in the asset class. This is exactly what has happened since 2009 and has no end in sight. The Tierra XP Latin America Real Estate ETF (LARE) is simply a response to evolving market conditions in Latin America and a solution for both institutional and individual investors to gain exposure to this key growth sector.

LARE is the first listed vehicle to offer diversified and unique access to the $60 billion+ public real estate industry at a reasonable cost and with the ability to capture attractive dividend yield without sacrificing growth prospects. More than 80% of the 52 components represent new access – meaning they are unavailable through competing products. Approximately 55% the components are real estate investment trust (REIT)-type equities, which by law must distribute all of their pre-tax income to the investor.

We expect the REIT market to grow significantly over the next five to 10 years as the local capital markets become the go-to place for real estate financing. We designed the multi-factor index around our 20+ years’ experience on the institutional private equity side of the business. In choosing the ETF wrapper, one of our goals was to democratize access and allow the individual investor to invest in a strategy designed for institutions.

My partners and I have been active in the Latin America region since the early 1990s. Apart from being a specialist in the region, we also tried to inject our real estate private equity experience into the product. One of my partners is a Rio de Janeiro-based portfolio manager. My other partner and I began our careers in Mexico City in 1993.

To be honest, the turn toward local public market financing since 2009 is a development we would have never thought possible back in the mid-1990s. But when one steps back, it’s just standard, predictable capital markets evolution.

Investment Strategy

Ho: What is the investment strategy for your ETF? How do you go about picking the holdings? What are the rules for reconstitution?

Anderson: LARE is a passive product and seeks to track the Solactive Latin America Real Estate Index, which currently has 52 components. Brazil is weighted 58%, Mexico is 39% and Chile is a little less than 3%.

REITs comprise about 55 % of the portfolio with the balance being developers, owners and service providers. This is the growth piece. The index methodology screens more than 150 listed real estate equities in the region and ranks them against the population set based on dividend yield, market cap and liquidity at each quarterly rebalancing.

The index includes most major public real estate owners and operators, developers and real estate services. It’s a diversified and balanced slice of the entire industry.

Rapid Growth Projections

Ho: What catalysts will drive performance in the industry? What are their projected sales and earnings growth?

Anderson: On a trailing basis, LARE trades at 16.6 times earnings as of Jan. 28. We project a 14.8x forward price-to-earnings (P/E) ratio – or about a 10 % discount. Overall, revenue growth is projected to be flat in 2016. But earnings are set to grow 28 %.

So what we have is a basket of diversified real estate companies that, in aggregate, have cleaned up their balance sheets over the last three years and are growing earnings in a flat sales growth environment. There is tremendous built-in operating leverage when overall growth picks up.

Notably, it’s important to mention projected revenue growth for Mexican REITs is 21% , which comprises 23% of the overall weights.

LARE is a regional product with exposure to Brazil, Mexico and Chile (which are tracked by iShares MSCI Brazil ETF (EWZ), iShares MSCI Mexico ETF (EWW) and iShares MSCI Chile ETF (ECH), respectively.)

Growth catalysts differ by country. Brazil, for example, is entering its third year of recession. Forward performance is largely dependent on improvements in the overall economy, which we think are underway. Since the market is a discounting mechanism, which prices in future earnings, investors are starting to put money to work there on expectations that Brazil’s economy will bottom during 2016 if it has not already.

In the second half of 2015, Brazil’s current account surplus grew to more than a 5% rate, cutting the current account deficit in half compared to 2014. Brazil’s gross domestic product (GDP) in 2016 is projected to fall 2.5%. However, this is an improvement compared to the 3.7% contraction in 2015.

The central bank has aggressively raised interest rates in the face of high inflation, which was brought in large part by transportation and fuel price increases last year. Real estate and assets, in general, are very discounted, with real estate trading close to half of book value.

An investor in LARE can have access to Brazil REITs with unleveraged yields of 10% to 15%, trading at a 40% discount to book value and a forward seven times P/E. That is dirt cheap for commercial real estate with stabilized lease cash flows.

Mexico and Chile continue to be favored by foreign investors. Mexico tracks the U.S. economy very closely and is going through a real estate renaissance fueled by low-interest rates, stable growth, low inflation and a growing middle class. The rise of local pension capital will also continue to be a major driver of real estate development.

 James Anderson is managing principle at Tierra Funds. (James Anderson)

James Anderson is managing principle at Tierra Funds. (James Anderson)

On the downside, Mexico is not cheap. Its benchmark index trades at an approximate 20% premium to the S&P 500 (SPY). But it is growing faster than the U.S. However, Mexico REITs are quite attractively priced, trading at 14 times trailing earnings with a projected 13.5 times earnings on a forward basis, or a 25% discount to the Mexico benchmark (iShares MSCI Mexico ETF (EWW)).

If we step back, Brazil is a discount, get-paid-to-wait story. And Mexico is a GARP (growth at a reasonable price) story. By combining Brazil’s high yield with Mexico’s growth, an investor has the best of both worlds inside the convenience of the ETF structure.

Broadly speaking, demographics favor real estate across the board in both Mexico and Brazil, including residential, commercial office, retail and industrial. There is a long runway regarding housing needs, retail, industrial, etc. That isn’t going to slow for many years.

The real determinant in the short run is macro conditions. Economic growth can reignite just as quickly as it drops off. We have witnessed this phenomenon many times. The key is to buy into assets when they are cheap.

Bargain Valuations

Ho: How do their current valuations compare to historical and the S&P 500 (SPY)?

Anderson: Long-term comparisons between the S&P 500 (SPY) and public real estate are difficult since many companies in LARE have only been publicly traded since 2010. LARE began trading publicly in December 2015. But we do have live index data back to September 2015 and two years’ of third-party back testing.

The major impact over the last two years on index performance was currency. And this has been a global emerging market theme. Brazil’s currency has declined more than 35% and Mexico’s is down about 30% (against the U.S. dollar).

In 2014, Brazil REITs were trading at 15x to 17x trailing P/E vs. 10x currently. Mexico REITs are a harder comparison since many of them went public throughout the last three years. But regarding price to book value, Mexican REITs currently trade at 0.9x book value, which is more than 30% below where they debuted on public markets. The attractiveness of the discounts, we feel, is one of the most compelling aspects of LARE.

Ho: What is the historic performance of the underlying strategy or index?

Anderson: Regarding performance since September 2015, which was the period just after the sharp August sell-off, LARE has outperformed not only the Brazil and Mexico benchmarks (iShares MSCI Brazil ETF (EWZ) and iShares MSCI Mexico ETF (EWW)) but also the global emerging markets benchmark (iShares MSCI Emerging Markets ETF (EEM). Notably, LARE exhibits much lower volatility than Brazil (EWZ) and very similar volatility to Mexico (EWW) and the global emerging market benchmark.

LARE price return (PR) and LARE total return (TR), despite having a 58% Brazil weighting, dramatically outperformed the Brazil benchmark, iShares MSCI Brazil ETF (EWZ). The Index has a trailing yield of approximately 7.2%, as of Jan. 27, which is a pretty compelling get-paid-to-wait proposition.

Ho: How do you expect your ETF to perform over a bull and bear market cycle?

Anderson: We’ve been involved in the Latin America real estate industry for almost 25 years. We’ve been through multiple cycles, including the 1994 Tequila Crisis, the 1998 Asia Crisis and the 2003 Brazil Crisis.

Real estate, next to cash, is a sweet spot for local investors and tends to act as a safe-haven asset. We believe this is one of the reasons why real estate equities are less volatile than overall equities.

Anecdotally, you could have purchased new Class A office space during the depths of the Mexico Tequila Crisis in 1995 for about $100 per square foot. Today, Class A office space trades at around $400 per square foot. This is over a period where the Mexican peso lost more than 80% of its value versus the U.S. dollar. In nominal terms, that’s more than 700% appreciation.

For the long-term investor, real estate should provide a cushion against volatility while paying an attractive dividend. In bull periods, real estate is a natural beneficiary of stronger capital investment and growth. But the trade-off is you aren’t going to get the same rip higher when everyone decides that EM is the place to be. That said, minimizing losses is one of the key determinants in long-run asset appreciation.

Ho: Why should investors invest in your ETF? What purpose would it serve in their portfolios?

LARE is an ideal complement or proxy for emerging markets exposure that may provide a substantially more attractive current dividend yield with broad exposure to all economic sectors – consumer, industrial and commercial. We also think LARE is a compelling addition to an income portfolio overall.

For example, LARE, alongside the iShares JP Morgan USD Emerging Markets Bond ETF (EMB), would add material income plus growth potential at roughly the same volatility. Many consider real estate to be a bond-like asset with some of the growth potential of a traditional equity.

Finally, emerging markets real estate (Guggenheim Emerging Markets Real Estate ETF (EMRE), contrasted with developed markets (iShares International Developed Real Estate ETF (IFGL), is growing operating cash flow. Developed market real estate (IFGL) in general is either selling assets or borrowing to pay dividends. Payout ratios among some of the leading U.S. REITs are well above 100 %. Latin America REITs have payout ratios of roughly 60 %.

Investment Risks

Ho: What are the investment risks that investors should consider?

Anderson: Investors should always consult with their financial advisor prior to making investment decisions as well as read an investment’s literature. Ours is available at Major risks in our opinion, are a continuation of the U.S. dollar strengthening and a deterioration of economic fundamentals in Brazil.

The trade weighted dollar has rallied about 30% since 2014. Being long U.S. dollars is now a very crowded trade. In fact, since the Federal Reserve hiked interest rates in December, the dollar has actually stabilized, which suggests we may have seen the brunt of dollar strengthening – a little bit of buy the rumor, sell the news.

Given the impact of the stronger dollar, I can also imagine the Fed holding off on further rate hikes for at least the first half of 2016, if not longer.

On the Brazil front, we are really starting to see constructive signs that the economy is stabilizing. The main issues are their current account deficit and inflation. 2016 is projected to have the first annual surplus since 2014.

Inflation remains hot but many believe it is set to stabilize and drop as we get further into 2016 and government controlled price increases last year were a major contributor to the spike in the indicator. Since Brazil’s central bank began hiking interest rates two years ago, they are actually much closer to a cut in rates which should spark a rally in assets across the board.

Most have heard something about the political mess and the potential for President Dilma Rousseff to be impeached. While we are somewhat agnostic as to whether or not Rousseff survives her full term, we are increasingly convinced that this political paralysis can actually play into investors’ hands if we continue to see improvements on the economic front. A hobbled leader has little hope of pushing an agenda.

Also, don’t lose sight of the tectonic shift in the country’s desire to cleanse the political system of corruption. It is a major change in tolerance for what has been problematic for way too many years.


Ky Trang Ho founded Key Financial Media, which ghostwrites articles for financial services providers and business leaders. Follow me on Facebook, G+LinkedIn and Twitter.