Big Real Estate Fund Launch Echoes Internet Fund Debacle

Amid the fallout of the 2000-02 bear market, one of the fund industry's biggest embarrassments was the slew of Internet funds launched just before the bubble burst. Big fund companies like Merrill Lynch and Strong and small shops like Amerindo, Turner, and Westcott launched funds that soon lost a lot of shareholders' money. Nearly all of those mistakes have been swept under the rug (that is, merged away or liquidated) but you can click here to see a few of the gems that came out.

In light of that debacle, many fund company executives vowed never to repeat that again. They recognized that their greed for assets blinded them to the need to do what's right for fundholders and that it's just plain wrong to launch a fund that you wouldn't touch.

Yet here we are, eight years later, and the fund industry has launched a truckload of real estate funds on unsuspecting and/or greedy investors. All told, 37 real estate funds have been launched this year (including those launched on the last day of 2006). The timing of those launches is just downright atrocious.

Consider some of the since-inception returns: IShares FTSE NAREIT Mortgage (REM) has lost 40% since inception, Ultra Real-Estate Proshares  is off 45%, and Cohen & Steers European Realty  is down 27%.

REITs enjoyed a tremendous run from 2000 through 2006, to the point where it was pretty clear that they couldn't continue their pace. And while real estate funds typically buy commercial real estate securities, the mania in the housing market helped stoke investors' fervor for all things real estate. We saw rampant dot-com-style speculation in new homes, complete with two TV shows telling you how to flip a house. (Are they still on the air? If so, maybe they can tell people how to file for bankruptcy.)

So, most in the fund industry had to know that this year was a bad year to dive into real estate even before subprime joined the national lexicon. Plenty of real estate fund managers were telling us last year that REITs had become pretty unattractive, and we were also sounding cautionary notes. In September 2006, our John Coumarianos wrote: "Real estate is a good diversifier, but now's the time to trim, rather than add to, a position." Even in 2005, Christine Benz urged readers not to speculate in real estate and pointed to past severe corrections in residential real estate. In addition, stock analyst Craig Woker wrote a piece titled: "Real Estate Is the New Dot-Com: How to keep from getting burned in an overheated market." If we knew real estate was a bubble, you can be sure those launching funds knew it, too.

A fair number of the funds launched were global real estate funds, and I'll cut some slack on that count, given that REITs are fairly new overseas and it hadn't gotten as crazy overseas as here. But it's still a trendy launch, and the losses at Cohen & Steers Euro Realty illustrate that they have downside, too.

A new element in trendy fund launches is exchange-traded funds. They were still in their infancy for the dot-com boom, but they are in full swing today, and some can't resist any hot trend. Adelante has launched seven new real estate ETFs. Barclays has launched six new real estate iShares. The two firms are also at the forefront of carving out small niches in real estate that are reminiscent of the B2B funds launched in 2000. Adelante appears to have sliced real estate holdings by style so that there's growth, value, and yield. Barclays did subindustries such as residential and retail.

What's missing in this is that fund directors, managers, and executives aren't taking a step back to ponder their duty to fundholders. Should they launch something that they wouldn't touch? Are fundholders being served well when fund companies crank up marketing efforts after an extended run? Should we encourage investors to buy based on short-term performance?

If there's a silver lining here it's that many of the largest fund companies refrained from encouraging bubble investing. American, Vanguard, Fidelity, T. Rowe Price, AllianceBernstein, and Putnam are not on the list of those launching new real estate funds.

Poll Results
Here's how you voted in two recent polls:

Which fund is the best bet for a rebound?

28%--Fidelity Magellan

32%--American Funds Washington Mutual

14%--American Century Ultra

26%--Calamos Growth

In light of new manager defections at Janus, investors should:

26%--Keep the faith given strong recent returns.

44%--Limit investments to a couple of proven managers still there.

30%--Stay away.

Disclosure: Morningstar licenses its indexes to certain exchange-traded product providers, including Barclays Global Investors (BGI), First Trust, Claymore, and Merrill Lynch, for use in exchange-traded products. These exchange-traded products are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in the exchange-traded products that are based on Morningstar indexes.