A reader left a question asking how much to allocate to REITs in a portfolio. He noted David Swensen's 20% suggestion and wondered if that number is too high. The reader also asked about foreign REIT exposure.To me this is kind like asking how much to put in commodities. For either there is no shortage of smart people and well written white papers suggesting big numbers to these asset classes.
To be clear I am not going to out-debate anyone on this point and anytime I write this sort of post someone will leave an articulate comment saying why a diversified portfolio should have more exposure than the sorts of numbers I kick around.
If you think about the various asset classes available that help bring a portfolio away from looking like an index fund you could quickly get to owning nothing but the diversifiers (small hyperbole). There's REITs, commodities, infrastructure, a call writing something or other, absolute return and you might have a couple to add to the list that I'm missing.
Swensen says 20% to REITs, there are some that would say 20% to commodities and I imagine the other segments I mentioned each have fans that would argue 10%. If you pull in all those disparate opinions you'd be 70% in diversifiers and 30% equities. I doubt too many people think that would be a good idea.
One thing that needs to be incorporated into the thought process is that stocks have been the best performing asset class over long periods of time (we've all seen that Ibbotson's chart). The various diversifiers, from where I sit, are for smoothing out some of the volatility that goes with owning equities, they are not intended to be substitutes.
Additionally, every so often something goes wrong with these sorts of things. Over the last 12 months iShares REIT (IYR) is down more than the Financial Sector SPDR (XLF). Long time readers will know I only had one across the board REIT name at a 2-3% weight, that it did poorly and that I sold it in December and have not replaced it. That one stock, at 2-3%, was it for several years. I generally believe REITs offer diversification benefits but of all of the niche things in my ownership universe my comfort level with REITs has never been that high.
For some of themes I would consider two holdings at 2-3% each but can't see it for REITs. As far as foreign goes, the Hong Kong markets gets written about like it is the healthiest market out there but I just read something somewhere that said because of HKD's peg to the greenback, rates in HK were lowered but their inflation rates makes the cuts a bad idea and mortgages their are much cheaper than they should be so this creates visibility for a problem. I have no idea if there will be a problem but the path to one is easy to see.
While I am acutely aware that I am no David Swensen, 20% in REITs is way too much for me. The number I had been using might be too low most of the time but was lucky during the selloff of the last few months.
The picture is from New Zealand.
15 comments:
30% in equities and 70% in "diversifiers" is what Yale's portfolio looks like. Though not what Swensen recommends for individual investors. I wonder if that recommendation would differ for non-US individual investors who have access to products that the SEC doesn't allow low net worth US persons invest in. Truth is that many are listed on exchanges and so could be accessed by US individual investors who can invest internationally.
A major issue I see with your approach from the point of view of an individual investor is that you have clients and my impression from your writing is that their expectation is that you will capture the stock market beta one for one, with hopefully a point or two of alpha tacked on, but they would be upset if you lagged the stock market too much in times when it was up. OTOH the individual investor only has one client and may be happy to see fairly consistent absolute returns even if they lag the market in big up years. This isn't a criticism of you, but merely a statement that different investors have different preferences.
One thing that needs to be incorporated into the thought process is that stocks have been the best performing asset class over long periods of time (we've all seen that Ibbotson's chart). The various diversifiers, from where I sit, are for smoothing out some of the volatility that goes with owning equities, they are not intended to be substitutes.
I guess the thought/comment I would have on this point is what are we talking about when we say "long period of time" and what is the long period of time that is important. Few if any individual investors have a 50+ year time horizon on their investment portfolio, where 5-10 years could be a significant chunk of time in the accumulation phase.
So start in 2000 and look at the past 8 years. I'd argue that 8 years is a "long period of time". Over the past 8 years, REITs and commodities have outperformed the S&P 500 by an absolutely *ENORMOUS* margin, but I'd argue that in 2000 the S&P 500 was trading at bubble valuations, while REITs and commodities were cheap and out of favor.
IMO, it is really hard to just make a blanket statement about exactly what percentage in what. There is no substitute for thoughtful analysis that looks at the value and upside potential of a particular asset class at that point in time.
Incidentally, I read the article that Ron provided the link to (thanks Ron). Here is an excerpt:
At least one caution is in order. The time frame of this analysis (1970 to 2006) was a period of robust returns across the board. Equities averaged in excess of 11% annually, intermediate bonds averaged over 8%, commodities generated over 11% and REITs returned roughly 13.5%.
That is 36 YEARS! For most people, that constitutes an investing lifetime. So at least over that period of "long-term" equities did NOT outperform commodities and REITs.
Nobody knows what the next 30 years will hold, but going 60% equities, 20% REITs, and 20% commodities probably isn't going to result in disaster. My own approach is to use a combination of fundamental and technical criteria to make the appropriate overweights and underweights.
NO REITS
Equities were in a bubble in 2000. Real estate is coming out of a bubble. Commercial real estate lags homes by 6 to 9 months normally. REITS are going to continue to perform poorly for years.
4 to 8 years from now REITS might make a lot of sense even at 10 or 20% IMO. But looking at the recent past that includes a bubble makes me just want to avoid this area for years to come.
I think we are going to get that rally in equities. Hopefully before I go on vacation.
SEG
Hi Roger, nice crib, do you have any more details?
To be honest, I think the bigger question is WHICH REIT. Heh. It seems to be one of those things where you keep doing research and end up with even more questions.
I'm not sold on the Wisdomtree product. I find it funny that they were rolled out at the height of a bubble and now they're making excuses for last year's performance.
I'm not sure WHAT my opinion is of the iShares global REIT yet.
The Vanguard REIT index has a couple of limitations as to what it can invest in.
Guess it's all a learning process.
Mike C, the accumilation phase might be 30 years but you need growth during the drawdown period which could also be 30 years.
jimidean, the house is in Whangerei (pronounced Fahngerei). A friend owns a house around the corner from this one but the one pictured is more interesting. The rounded roof line shows up here and there in NZ. It was for sale for a while at about NZ$1 million but the owner died in an accident involving his tractor I'm said to say and do not know if it is on the market currently.
SD, you talk of learning more, so what about studying individual issues?
Stephen--If you can stomach CEFs, you might want to take a look at AWP. I'm a little underweight on REITs in my portfolio for all the obvious reasons (5% target), but IMHO, the risk/reward for AWP is quite favorable now.
I've read Swensen's book and am wondering why he doesn't advise individual investors to buy commodities (in whatever form). Does anyone have an idea why? Are the expenses too high on the commodity ETFs out there? 20 percent in REITs is also too high for my comfort level.
Roger, do you think the allocation to REIT's should be influenced by real estate you hold directly? If you own rental property and a fairly expensive house (in California even a modest house is still expensive)you may already have 20% or more of your net worth in real estate.
that is a tough question with no right answer. i lean "no" without a lot of conviction.
IYR is down 30 something percent in the last 12 months. i doubt too many rental properties have gone down like that meaning the correlation between a building and a REIT could be low.
my opinion has been the same but i don't think i make a convincing argument.
Roger,
To use your expression, I think that tweaking an overweight/underweight in certain asset classes is "in your wheelhouse" or at least consistent with how you steer your port. You do it with shorts and you have done it with financials, energy, and emerging exposure...why not hard assets IF there is technical/fundamental rationale for a longterm shift. Broad asset class designations DO tend to stay with relative weakness/strength for long periods of time..whether the trend(is secular10-25 yrs) or primary(9-months-2yrs). ps...I revisited Martin Pring
http://tinyurl.com/yt3a6a and...for the moment this reading has added some clarity to positioning the portion of my port with a longer horizon. The real magic, though, I think, is having a guideline as to WHEN the odds favor that shift to value, growth, bonds, equities, hard assets, etc. And, that would require back testing data. Question: anyone know if and under what conditions that hard assets (gold, grain, reit, whatever) tend to outperform equities/paper for long periods of time? Could be that the recent sell off in reits is one of those reactive shortterm trends that will look like noise in the bigger picture years from now. Having said all that, I tend to agree with Roger about reits per se but do think that hard assets, in general, are looking to be in a secular trend that started some years back.
Roger...please keep writing about the new etfs and adding your own evaluative opinion.
jasper
Jaqsper, a couple of things. adding in commodities, regardless of how much, is adding volatility. obviously it is usually a vol that has a low correlation to equities but i beleive there comes a point where the low correlation effect goes away and then you have a volatile commodity portfolio. i don't know where that number is but i do not want to come close to that number.
another aspect is that commodity cycles are either not a easy to read as stock market cycles or i simply know less about commodities than i do equities (I suspect both apply).
i beleive i caught on early to commodities but i clearly have more to learn.
Mike C The Portfolio with 7 asset classes was determind to be the best in the distribution phase, so I didn't look at it as a very long term portfolio but rather one that had the best record for lowest single year drawdown during a 37 year period. Also, the probobility of recovery from a 10% loss in 3 years was second best at 54.3%. The frequency of a cumulative loss of 10% or worse for one, two and three years was 0% and the worst single year drawdown was -10.2%. What's important to me as a 74 year is low drawdowns in short period not what I can earn in 20-30years. I will be taking distributions and not regularly adding new money. I would also rather take my distibutions from capital gains rather than interest income.
Ron
Re: "The Crib" (Not a financial comment)
I lived in NZ for a few years and have a good number of friends there who tell me property has just started to stall. The inner city building was growing steadily for the past ten years (as the country was shifting from the suburban "1/4 acre and a shed" dream to a more urbanized, youth invigorated inner city). Restaurants, for example, in Wellington (the Capital, albeit about the population of Des Moines), surpassed (on a per capita basis) Manhattan - and this after being limited to truly only a handful as late as the mid-1970s.
The employment situation remains very tight - they continue to solicit qualified professionals. But that may be the stone at the center of the fruit: much of the reason there is a shortage of professionals has to do with flight of intellectual capital. (Almost all young Kiwis spend a couple of years abroad before they turn 28 - on an "OE" (overseas excursion) - but in the last twenty years, more left than returned.
For all it's beauty, NZ remains at the end of the earth. The sense of isolation is palpable, and while the returnees have done an amazing job at bringing the country up to the leading edge of wine, food and selections of culture, they can't bring it closer to London (with whom the Kiwis have a particularly close affection).
If you love Rugby, the great outdoors, and are happy enough with the internet and electronic access, it's a dream come true. If it might bother you that it's nearest neighbor with over 1mm population is Australia, (a 3 hour flight), and that you are 8-9 hours southwest of Honolulu, or 22 hours from London, and 22 hours from NY (by air), then visit away, but be careful what you wish for (i.e., the idyllic life in the rural crib).
Rick in NY
PS: It doesn't help that they absolutely love visitors, but treat ex-pat Americans like the holiday guest who just won't go home.
rick, ty for the nz comments.
we explored buying something after our visit in 2005, we liked it that much.
but the process of getting there is daunting. 24 hours door from where we live in AZ including a 12 hour flight from LA. a couple of those a year is too much and we'd want to go more than twice a year.
i think we will visit again, want to hit the south island but living there would be difficult for work, the US market opens at 2:30 am, ouch.
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