Why Vanguard Real Estate Index Is One of the Best

Key Morningstar Metrics for Vanguard Real Estate Index Fund

• Morningstar Medalist Rating: Gold
• Process Pillar: High
• People Pillar: Above Average
• Parent Pillar: High

Vanguard Real Estate Index VGSLX and Vanguard Real Estate ETF VNQ are among the best U.S. real estate funds available.

The strategy charges very little for a broad portfolio that accurately tracks the U.S. real estate market, spreads its bets over dozens of holdings, and follows the market’s collective wisdom about their individual valuations and prospects by market-cap weighting. The strategy’s efficacy affirms a Morningstar Medalist Rating of Gold for the admiral, institutional, and exchange-traded share classes and warrants an upgrade for the pricier investor share class to Gold from Silver.

This fund fully replicates the MSCI US Investable Market Real Estate 25/50 Index, which mostly consists of equity real estate investment trusts. Equity REITs own and operate income-producing real estate, so this portfolio is a good proxy for the U.S. real estate market. Some real estate management companies squeeze into the index as well, but they tend to represent less than 5% of the portfolio.

The fund weights securities that make the index’s cut by market cap, a cost-efficient tack that channels the market’s collective view on the relative value of each holding. Most portfolio additions attract significant investor attention, so they tend to be priced accurately. Market-cap weighting also helps mitigate turnover and the related transaction costs. The fund’s benchmark also employs buffers designed explicitly to limit those costs.

Market-cap-weighted sector index funds can be concentrated. This index’s broad reach and constraints keep it out of trouble. The top 10 holdings accounted for between 36% and 50% of the portfolio over the past five years; its average peer ranged from 45% to 65%. Specialized REITs form 28% of the portfolio, but their variety alleviates concentration concerns. The fund had tended to land near the center of the Morningstar Style Box with names like cheap office REIT Vornado Realty Trust VNO and richly valued data center operator Digital Realty Trust DLR at opposite ends of the value-growth barbell.

This portfolio’s dimensions mimic the average U.S. real estate Morningstar Category fund. The portfolios lean into different property types on occasion, but their market-cap and value-growth orientations are nearly identical. That’s the point: by mimicking the category average at very low cost rather than trying to beat it while charging a higher fee, the fund gives itself and its investors an excellent shot at strong category-relative performance over the long term.

Vanguard Real Estate Index: Performance Highlights

Since adopting its current benchmark in February 2018, this fund has built on the solid track record it had compiled with its previous index. Its admiral shares beat the category average by 68 basis points annualized from that point through December 2023. Solid contributions from specialized REITs powered returns over that span, but the fund’s very low costs are its true edge. All share classes rank in the U.S. real estate peer group’s cheapest decile, and low turnover equates to few transaction costs.

This simple, well-diversified fund should fare best when markets favor public U.S. real estate and its biggest companies. The strategy holds less cash than most of its active peers, which boosts performance when markets rise but can spell trouble when they fall.