If there’s such a thing as consistency in the capital markets in the 21st century, real estate investment trusts are the standard. Although the asset class has had its share of frights from time to time, REITs nonetheless managed to right themselves and post gains once the dust cleared.
The tendency to post returns in the black is again on display in 2006. So far this year, through last night’s close, REITs are up 9.30%, as per Vanguard REIT Index Fund. And as our chart below shows, REITs are also the leading asset class ranked by returns for the past month through yesterday. To find a calendar year in which REITs shed ground one has to go back to 1999, when the category retreated by 4.0%.
Asset class proxies: Vanguard REIT Index VIPER, iShares Russell 2000, iShares MSCI Emerging Markets, MSCI EAFE, S&P 500 SPDR, Vanguard High-Yield Corporate, PIMCO EM Bond, Morningstar Short Gov’t Category, PIMCO Foreign Bond, iShares Lehman Aggregate Bond, Vanguard Inflation Protected Securities, PIMCO Commodity Real Return.
Such consistency is otherwise unavailable in the competing asset classes, at least when considered through the prism of recent performance. Foreign developed government bonds (based on the dollar-hedged PIMCO Foreign Bond Fund) appear to be a close second, as our chart shows. Indeed, this asset class also hasn’t had a down calendar year so far in this century. But where the category stumbles is absolute total return. PIMCO Foreign Bond posts a 5.24% annualized total return for the past three years through yesterday v. a sizzling 18.6% for Vanguard REIT Index Fund.
REITs, in other words, have no equivalent among the major asset classes when it comes to ongoing gains, high absolute performance over time, and a bull market that’s been second to none in consistency and stability.
So, what’s not to like? A realist might answer that question by pointing out that the laws of financial gravity haven’t been repealed, even if the recent empirical record for REITs suggests otherwise. At some point, all asset classes–particularly for those of the equity variety–go through relatively lengthy periods of pain. Yet REITs have largely sidestepped that awkward law that otherwise afflicts competing assets. Alas, assuming that the past dictates the future is an assumption that has cost investors dearly in the annals of finance.
To be sure, REITs appear to be beating the odds. And since investors are influenced more by recent rather than distant history, the tendency to project performance of late going forward is all too enticing.
By contrast, some (including your correspondent) has warned in the past that the fun has gone on for so long, and with such gusto, that cutting back on the asset class has been the only enlightened choice. Yet that enlightenment has come at a steep opportunity cost in recent years. Each and every sharp correction in REITs has quickly led only to a rally that brought prices to yet new record levels.
Paring asset classes that have run sharply higher over time while overweighting those that have suffered is a strategy we believe in. Unfortunately, that strategy hasn’t worked with REITs, although it seems to be reaping gains of late with emerging markets stocks. No matter, as we’re not willing to discard a strategy that has proven itself worthy over time. Diversification, in short, still matters, even if it suffers embarrassment in the short term.
There is no diversification without rebalancing. REITs, we’re sure, will one day correct. But not today, perhaps not this year, and perhaps not any time soon. But eventually, all bull markets must end. All of financial history offers no exceptions.
The question: how much will our diversification-inspired prudence cost us in an asset class that seems intent on defying the odds?