Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, November 13, 2017. You can also find the re-balance calendar for 2017 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

REITs As An Asset Class

REITs (Real Estate Investment Trusts) are companies that own or finance real estate. These companies, by law, have to pay out at least 90% of their income (mostly rental income) as dividends to their shareholders. Since these companies’ main business is in real estate that produces regular rental income ( (75% of their total asset should be in real estate), they are distinctly different from other companies like technology, industrial or health care that relies on selling products and services for profits.

Traditionally, REITs are classified as a sector in financial industry. In fact, even today, in stock screening tools provided by many brokerages,  they are treated as an special sector. However, MyPlanIQ believes they deserve to be a distinct asset class and have treated them as such. 

In the following, we look at the two most important factors that determine an asset class. 

Stocks like long term returns

To qualify as a major asset class, it has to produce a reasonable long term return. Investors derive returns from REITs through their dividends and capital price appreciation. The following return chart is courtesy from NAREIT (National Association of REITs):

The data are up to end of 2014. One can see that REITs have slightly outperformed S&P 500 for various periods up to 40 years. This is significant as we now have a comparable asset class that delivers stock like long term returns. 

However, REIT index funds like VGSIX (Vanguard REIT Index Inv) or IYR (iShares US Real Estate) do exhibit higher volatility. For example, VGSIX lost -63.7% alone in 2008, compared with -47.7% loss of S&P 500. It has maximum drawdown 73.1% that occurred from 2007 to 2009, compared with S&P 500’s 55.3%. Its standard deviation, a measure of daily volatility, is also higher than S&P 500: 26.8 vs. 17.8.

This implies that this asset has lower risk adjusted return, or Sharpe ratio. So it leads to the next question, does it add additional value to a portfolio?

Diversification and correlation with stocks

Fortunately, even though more often than not, REITs behave closely as general equity/stock market index, they do exhibit weak correlation at times, sometimes when general stock markets were in a dump. 

For example, the following table shows how they fared compared with S&P 500 (VFINX) during the technology induced bear market from 2000 to 2003. 

Fund Name 2002 2001 2000 1999 1998
VGSIX (Vanguard REIT Index Inv) 3.7% 12.3% 26.3% -3.9% -16.3%
VFINX (Vanguard 500 Index Investor) -22.2% -12% -9.1% 21.1% 28.6%

During that bear market, REITs became an excellent diversifier: producing double digit annual return while stocks lost over 40%. On the other hand, we also showed the returns of two additional years (1998 and 1999) that preceded 2000. In those two years, compared with S&P 500’s double digit returns, it had very meaningful loss. 

REITs had a negative correlation with stocks in those years. However, during the 2008-2009 financial crisis, REITs lost big. This is understandable: that bear market was caused by real estate debacle. 

Recently, REITs again have shown some divergence from stocks. For example, based on our Asset Trends and Correlation page, at this moment, it has the lowest correlation (0.38) with US stocks in the decade:

In a word, REITs can be a reasonable portfolio diversifier. It can have weak or negative correlation at times that can help to make a portfolio more stable. 

Recent weakness

REITs usually show weakness at the start of an interest rate hike cycle. This is because investors become more concerned about their income when interest rates are high — in such a period, REITs will have tighter financing condition and cost that in turns can hurt their income. However, once the rate hike cycle is near its end, REITs usually show strength as they have done their inflation/interest rate hike adjustment in terms of their rental income (by raising rental prices, for example) to fully compensate for the higher rates. So in a longer term, REITs can deliver above inflation excessive returns similar to stocks. 

The following table shows the recent weakness in REITs: 

Fund YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR
VGSIX (Vanguard REIT Index Inv) 5.5% 6.4% 9.8% 10.1% 5.8%
VFINX (Vanguard 500 Index Investor) 15.7% 22.0% 13.1% 14.5% 7.2%

It has had a noticeable weak return in the past one year. This reflects investors’ concern in the current rate hike period. 

REITs in asset allocation

Based on the above data, we make several observations: 

Market Overview

US stocks continued to break their record territory. Interest rate sensitive sectors like REITs, bonds and commodities did pretty well last week, probably reflecting investors’ lessening concern on rate hike effect. As summer is ending, stocks and other risk assets haven’t shown much weakness and continued to rise. Again, considering the very high stock valuation and low interest rates (that are rising), we are cautiously optimistic. Stay the course but manage risk within an acceptable range. 

For more detailed asset trend scores, please refer to 360° Market Overview

Now that the Trump administration has been in the office for more than half a year, it has stumbled and encountered many difficulties to implement its promised changes in terms of tax cuts, job stimulation and infrastructure spending. On the other hand, stocks continued to ascend, regardless of the progress. Looking ahead, however, we remain convinced that markets will experience more volatilities at some point when reality finally sets in. 

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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