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Diversified Funds with Big REIT Exposure

Some good managers are real estate fans, even after a strong run by the stocks.

David Kathman, 02/16/2010

Real estate investment trusts, traditionally seen as relatively staid diversifiers and sources of income, have taken investors on a wild ride in recent years. After several years of strong returns fueled by the real estate boom, many REITs got hammered in 2007 and 2008 as credit markets seized up. As doomsday scenarios receded and markets bounced back starting in March 2009, REITs posted big gains, though they're still well below the peaks they reached before the real estate bubble collapsed. For example, Simon Property Group SPG, the biggest U.S. REIT by market cap, was trading at $70 on Feb. 11--more than twice its March 2009 low of $26, but still about 40% off its $117 high from February 2007.

Real estate mutual funds, which mostly hold REITs, have followed a similar pattern. The average fund in Morningstar's real estate category lost 40% in 2008 and 30% in the first quarter of 2009, then rebounded strongly to finish last year with a 31% gain. As of Feb. 11, 2010, real estate funds had the best returns of any domestic-stock category over the past year, even after giving back some of their gains in recent weeks. Prominent real estate funds such as Fidelity Real Estate Investment FRESX and T. Rowe Price Real Estate TRREX are up more than 50% over the past year, even after losing about 8% for the year to date.

This rally has been encouraging, but there's still plenty of uncertainty, as the market's recent dip has illustrated. Are REITs still attractive, or have they become overextended given their big runup and the continuing uncertainty over real estate prices? There's no clear consensus, but even optimistic observers tend to be somewhat cautious. We decided to take a look at the diversified mutual funds with the biggest REIT exposure. Because these funds can invest in any sector, a big real estate stake is an active bet that implies their managers see real value there. Excluding sector funds and balanced funds and focusing on funds that are actively covered by Morningstar analysts, the following five have the largest percentage of their portfolio in REIT stocks. They're a diverse group, with different reasons for owning REITs, but they show that a number of top managers are still seeing value in real estate.

Fidelity Strategic Dividend & Income FSDIX
This fund had more than 15% of its portfolio in REITs as of Dec. 31, 2009, led by top-10 holdings Simon Property Group and Ventas VTR. However, that's by design; managers Joanna Bewick and Chris Sharpe keep roughly half the portfolio in common stocks, mainly big names such as J. P. Morgan Chase JPM, Pfizer PFE, and Verizon VZ, and the other half in income-producing assets such as REITs, convertible securities, and preferred stock. The fund's gyrations over the past few years have mirrored those of REITs (and convertibles). It trounced the large-blend category from 2004 through 2006, landed in the bottom quartile in 2007 and 2008, and has ranked near the top again over the past year.PAGEBREAK

Third Avenue Value TAVFX
This Fund Analyst Pick is managed by value-investing legend Marty Whitman with the help of comanager Ian Lapey. Whitman is a bargain-hunter and a big fan of asset plays, which he tries to buy at a discount of at least 20% to their net asset value. He tends to keep the portfolio concentrated in areas he likes, and right now one of his favorite areas is Asian real estate. As of Oct. 31, 2009, the fund's 12.8% REIT exposure came entirely from Hong Kong-based Cheung Kong Holdings, but another 26% of the fund was devoted to Hong Kong real estate developers Henderson Land Development and Wheelock and Company, and to Wharf Holdings, a Hong Kong conglomerate with a lot of real estate holdings. The fund's 45% gain put it in the world-stock category's top quartile in 2009, though it has had a tougher time so far in 2010.

Janus Overseas JAOSX (and Janus Aspen Overseas JAIGX)
At first glance, these funds (which are clones) look very different from Third Avenue Value, in that they're foreign large-growth funds whose manager, Brent Lynn, looks for fast-growing companies that will generate strong returns on invested capital. But Lynn, like Whitman at Third Avenue, sees opportunities in Asian real estate. REITs from Singapore (CapitaLand Limited) and Japan (Mitsubishi Estate) are among both funds' top holdings, and non-REIT Chinese property developers Hang Lung Properties and China Overseas Land and Investment are also prominent in the portfolios. After a tough 53% loss in 2008, Janus Overseas came roaring back with a 78% gain last year, one of the best of any mutual fund.

Stratton Small-Cap Value STSCX
As its name implies, this fund holds small-cap stocks with a value bent. As of Sept. 30, 2009, the fund's 86 holdings included eight REITs, led by Nationwide Health Properties NHP and SL Green Realty SLG. Manager Gerald Van Horn tends to avoid the more speculative small-cap names, and turnover is quite low for a small-cap fund. That cautious stance didn't help the fund in 2009, when it landed in the small-value category's bottom decile, but over the long run it has been a strong performer.

AllianceBernstein Wealth Appreciation Strategy AWAAX
This is a fairly aggressive fund designed as a one-stop equity holding. Although it's a large-blend fund, the six-person management team holds big stakes in small- and mid-cap stocks (which made up nearly 30% of the portfolio as of Nov. 30, 2009) and foreign stocks (which made up 37% of the portfolio). They also make a point of holding REITs, currently about 8.5% of assets. In keeping with the fund's big foreign weighting, most of those REITs are based outside the United States, with the three largest positions coming from France (Unibail Rodamco), Japan (Mitsui Fudosan), and Hong Kong (Sun Hung Kai Properties). As with several other funds on this list, this offering's aggressive nature hurt it in 2008, when it ranked in the large-blend category's bottom decile, and helped it in 2009, when it gained 32%.

David Kathman is a mutual fund analyst with Morningstar.

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