What's in a REIT Fund?

he performance of real estate investment trust (REIT) mutual funds have been impressive for several years now. So, we thought it would be interesting to take a deeper look at what actively-managed U.S. REIT funds typically invest in. Our real motive was to investigate the diversity of the holdings among prominent REIT funds. In other words, do REIT funds typically invest in mainline REIT stocks or do they wander into stocks that are only tangentially linked to real estate in hopes of boosting their performance?

First, a working definition of what a REIT is might be helpful. According to the Office of Thrift Supervision (Department of the Treasury), a REIT is "an investment vehicle established for the benefit of a group of real estate investors. A REIT is an unincorporated trust or association, managed by one or more trustees who hold title to the assets of the trust and control its acquisitions and investments. Real estate investments commonly include office buildings, apartment houses and shopping centers."

When a particular equity sector (such as REITs) heats up, (a) money often flows into the funds at an increasing rate (sadly, it's usually too late) and (b) the performance comparisons among funds in that sector tend to increase. Thus, simplistically put, REIT managers must invest potentially large inflows into a defined subset of stocks while attempting to avoid diluting the performance of the fund or exceeding their maximum allocation in any one issue. To put this into perspective, as of year-end 2005, there were about 180 U.S.-based REIT stocks according to Morningstar-representing the size of the shopping list for domestic REIT mutual funds if they shop only among domestic REIT stocks.

This study had four specific objectives. First, identify the prominent REIT indexes. Second, identify the dominant REIT stocks within the REIT indexes. Third, determine how closely the largest actively-managed domestic REIT funds align themselves with the REIT indexes. Fourth, explore the degree of diversity in the holdings of prominent REIT funds. REIT funds included in this analysis needed to have at least a three-year return (as of 12/31/2005), have at least 66% of their portfolio in U.S.-based equities, and have a Morningstar category classification of "Specialty-Real Estate". Index funds were omitted as were redundant funds (i.e., only one share class of a multiple share class fund was considered). There were 58 funds that survived the filters. Of that number, the largest 20 REIT funds were included in the analysis inasmuch as they represent about 80% of the total assets held among the 58 funds. All data used in this study were obtained from Morningstar Principia.

The three major REIT indexes are the Morgan Stanley REIT Index, the S&P REIT Index, and the Dow Jones/Wilshire REIT Index. In this study, we examined the portfolio holdings of the two REIT index funds or one REIT ETF rather than the holdings of the actual indexes. This was done because raw indexes are not "invest-able" whereas index funds and ETFs are. As shown in "REIT Benchmarks", the Morgan Stanley REIT Index is represented by the Vanguard REIT Index, the S&P REIT Index is represented by the Wells Fargo S&P REIT Index fund, and the Dow Jones/Wilshire REIT Index by the streetTRACKS WR REIT Index ETF. It is worth noting at this point that each REIT index had 100 +/- holdings as of year-end 2005. In terms of the number of portfolio holdings these three REIT indexes are very comparable. Moreover, each of these REIT Indexes is U.S. equity-based with virtually no foreign holdings.

REIT Benchmarks

REIT Index	“Investable” REIT Index Fund or REIT ETF	Number of Holdings in the Index Fund or ETF (as of 12/31/05)	Percentage of Portfolio Invested in U.S. Stocks
Morgan Stanley U.S. REIT Index	Vanguard REIT Index	109	97.4
S&P REIT Index	Wells Fargo S&P REIT Index	101	99.6
Dow Jones/Wilshire REIT Index	streetTRACKS WR REIT Index ETF	94	99.8

On to the second objective: namely, investigating which REIT stocks are dominant within the REIT indexes. We found 73 REITS common to all three indexes. The 20 REITs with the highest average portfolio weighting are listed in "Common Holdings." For example, Simon Property Group was the largest single holding in each index, with an average portfolio weighting of 5.92%. (The 20 REIT stocks in this table are arranged by average portfolio weighting). The next column in the "Common Holdings" shows the cumulative portfolio weighting demonstrating that on average, these 20 REITs represented more than half of the weighting of each index as of 12/31/2005. The last two columns list the number of actual REIT funds that held each stock (among the 20 largest REIT funds) and the accompanying portfolio weighting. Also noted in "Common Holdings" is the percentage of each REIT index invested in REIT stocks. This was determined by comparing the holdings of each index fund with the Morningstar categorization of each holding. For instance, 96% of the holdings in the Vanguard REIT Index Fund (which tracks the Morgan Stanley REIT Index) were categorized as REITs in the stock module of Morningstar Principia. By comparison, 92% of the holdings in the Wells Fargo REIT Index (which tracks the S&P REIT Index) were classified as REITs. The highest percentage (98%) was found in the streetTRACKS WR REIT Index ETF, which tracks the Dow Jones/Wilshire REIT Index.

Common Holdings

Top 20 Portfolio Holdings Held in All Three Major REIT Indexes (as of 12/31/05)   (Ranked by Average Portfolio Weighting in Three REIT Indexes)	Morgan Stanley REIT Index	S&P REIT Index	Dow Jones/ Wilshire REIT Index	Average Portfolio Weighting in Three REIT Indexes	Cumulative Portfolio Weighting in Three REIT Indexes	Number of REIT Funds Holding this Stock   (Among the 20 Largest Actively- Managed REIT Funds)	Average Portfolio Weighting Among 20 Largest Actively-Managed REIT Funds
Investable Index Fund/ETF Tracking the Index	Vanguard REIT Index Fund   109 Holdings	Wells Fargo REIT Index Fund   101 Holdings	streetTRACKS WR REIT Index ETF   94 Holdings	--	--	--	--
Percentage of Holdings Categorized as REIT Stocks by Morningstar	96%	92%	98%	--	--	--	--
Simon Property Group	5.69	5.13	6.95	5.92	5.92	20	6.21
Equity Office Properties Trust	4.91	4.95	5.15	5.00	10.93	15	2.82
Equity Residential	3.99	4.41	4.64	4.35	15.27	19	3.19
ProLogis Trust	3.98	4.16	4.40	4.18	19.45	19	4.46
Vornado Realty Trust	4.01	3.74	4.56	4.10	23.56	19	3.99
General Growth Properties	3.74	3.96	4.14	3.95	27.50	20	4.11
Archstone-Smith Trust	3.11	3.36	3.40	3.29	30.79	17	3.10
Boston Properties	2.89	2.42	3.38	2.90	33.69	18	3.66
AvalonBay Communities	2.30	2.48	2.70	2.49	36.18	17	3.34
Kimco Realty	2.22	2.32	2.73	2.42	38.61	14	2.50
Public Storage	2.07	2.14	2.54	2.25	40.86	16	2.95
Duke Realty	1.79	1.91	1.98	1.89	42.75	8	1.98
Developers Diversified Realty	1.77	1.86	2.00	1.88	44.63	15	2.36
Macerich	1.43	1.50	1.63	1.52	46.15	16	2.39
AMB Property	1.39	1.47	1.57	1.48	47.62	14	1.98
Apartment Investment & Mngt	1.36	1.44	1.49	1.43	49.05	7	1.45
Liberty Property Trust	1.36	1.43	1.46	1.42	50.47	11	1.41
Regency Centers	1.41	1.38	1.44	1.41	51.88	17	2.19
Federal Realty Investment Trust	1.18	1.25	1.34	1.26	53.14	11	1.96
United Dominion Realty	1.19	1.19	1.21	1.20	54.33	11	1.72

The third objective was to determine how closely the largest actively-managed domestic REIT funds aligned their holdings with the three major REIT indexes. This was partly answered by the blue columns in "Common Holdings" which demonstrates that the 20 core REIT stocks held in all three major REIT indexes are also held by the vast majority of the 20 largest REIT funds. The exceptions include Duke Realty (held in only 8 of the 20 largest actively-managed REIT funds as of 12/31/05) and Apartment Investment and Management (held by only 7 funds).

In "REIT in Line" the third objective is explored a bit more deeply. We found 37 REIT stocks that were held in at least half of the 20 largest REIT funds (the 20 largest REIT funds are listed in "The Big 20"). Among these 37 REITs, 34 were also held in all three REIT indexes. Two stocks (Host Marriott and Trizec Properties) were in two of the three indexes, while one stock (Ventas) was held in only one index. Overall, the core holdings of the largest actively-managed REIT funds tend to be highly congruent with the core holdings in the three major REIT indexes.

We now turn to the fourth objective, an investigation of portfolio diversity within REIT funds. As shown in "The Big 20", all but one of the 20 largest REIT funds has far fewer portfolio holdings than the major REIT indexes (which are highlighted in green). The average number of holdings among the 20 largest REIT funds was 57, compared to an average of 101 holdings among the three REIT indexes (i.e., the three major REIT index funds). The next column in "The Big 20" lists the percentage of each fund invested in REIT stocks that are held by all three REIT indexes. On average, nearly 73% of each fund's holdings are also found in the REIT indexes. However, several funds were well below that average figure (Franklin Real Estate Securities A, Alpine Realty Income & Growth Y, and CGM Realty). For the Franklin and Alpine funds, summing the individual portfolio holdings (as reported in Morningstar) only accounted for 83% and 89% of the portfolio, thus it is difficult to draw precise conclusions regarding their lower overlap percentages (42.1% and 48.6% respectively) with the holdings in the REIT indexes.

CGM Realty is a different story. Its portfolio was fully accounted for and it still only registered a 52% overlap with REIT stocks held in all three indexes. Even more compelling is the data in the next column, the percentage of each fund held in non-REIT stocks. CGM had 33.6% of its portfolio in non-REIT stocks as of year-end 2005. The three most prominent non-REIT stocks held in the REIT funds in this study were Starwood Hotels and Resorts Worldwide, Hilton Hotels, and Brookfield Properties. Starwood was held by 15 of the top 20 funds and had an average portfolio weighting of 3.99%. Hilton was in 12 of the largest 20 REIT funds with an average weighting of 2.40%, and Brookfield Properties was in 11 of the largest 20 funds with an average weighting of 3.01%. Starwood and Hilton are classified by Morningstar as being in the "Hotels" Industry while Brookfield is classified in the "Real Estate" Industry (as opposed to the "REIT" Industry filter used in this study). Clearly, these three stocks-while not technically classified as REITs-are closely related.

Were these the types of non-REIT stocks held by CGM? No. In its portfolio of 20 stocks, five were non-REIT stocks as of 12/31/05. Of those five, four were in the energy sector (highlighted in yellow) and one was in the Real Estate industry. The portfolio weightings are shown below. The bulk of the non-REIT holdings in CGM were not clearly linked to REITs, unless there is a relationship between the coal industry and the REIT industry that we are unaware of. Not surprisingly, the 3-year annualized return of CGM Realty (48.35% as of 12/31/05) was markedly higher than the other 19 REIT funds.

Non-REIT Holdings in CGM Realty

Stock	Sector	Industry	Portfolio Weighting  (%)	3-Year Annualized Return (%) (as of 12/31/05)
Consol Energy	Energy	Coal	7.79	58.9
Arch Coal	Energy	Coal	7.29	55.7
CB Richard Ellis Group	Financial Services	Real Estate	6.42	n/a
Peabody Energy	Energy	Coal	6.37	79.9
Foundation Coal Holdings	Energy	Coal	5.77	n/a

To summarize, recent performance of prominent actively-managed REIT funds has been comparable with the performance of two major REIT index funds and one major REIT ETF despite having about half the portfolio holdings of the REIT indexes. The core portfolio holdings of REIT funds is, in most cases, very similar to the core holdings of REIT indexes. Where there is performance discrepancy between a REIT fund and a REIT index (i.e., index fund) it most likely represents a foray into non-REIT stocks.

When it comes to REIT fund holdings, it shouldn't be surprising that the mantra is "location, location, location". That said, about the only way for an actively-managed REIT fund to generate a significantly different return than REIT indexes is to change the location of its holdings. At that point, is it still a REIT fund or a sector fund with mobility? This may be important if a REIT fund has been selected for inclusion in a portfolio based upon its low correlation to other portfolio holdings. A fund that stays put in REIT stocks should maintain the low correlation whereas a fund that strays too far from REIT stocks may manifest correlation patterns that are unanticipated-and counterproductive from a portfolio standpoint.

REIT in Line

37 REIT Stocks Held in at Least 10 of the Largest 20 REIT Funds	Number of the REIT Funds Holding the Stock   (Among the Largest 20 Funds)	Average Portfolio Weighting in REIT Funds (%)	Number of REIT Indexes Holding this Stock	Average Portfolio Weighting in Index Funds (%)
Simon Property Group	20	6.21	3	5.92
General Growth Properties	20	4.11	3	3.95
ProLogis Trust	19	4.46	3	4.18
Vornado Realty Trust	19	3.99	3	4.10
Equity Residential	19	3.19	3	4.35
Host Marriott	19	3.00	2	2.23
Essex Property Trust	19	1.46	3	0.77
Boston Properties	18	3.66	3	2.90
AvalonBay Communities	17	3.34	3	2.49
Archstone-Smith Trust	17	3.10	3	3.29
Regency Centers	17	2.19	3	1.41
Public Storage	16	2.95	3	2.25
SL Green Realty	16	2.55	3	1.13
Macerich	16	2.39	3	1.52
Equity Office Properties Trust	15	2.82	3	5.00
Developers Diversified Realty	15	2.36	3	1.88
Pan Pacific Retail Properties	15	1.57	3	1.04
Mills	15	1.52	3	1.09
Kimco Realty	14	2.50	3	2.42
AMB Property	14	1.98	3	1.48
Arden Realty	13	1.98	3	1.14
Alexandria Real Estate Equities	13	1.97	3	0.69
Kilroy Realty	13	1.42	3	0.65
Reckson Associates Realty	12	1.87	3	1.12
Camden Property Trust	12	1.58	3	1.15
CenterPoint Properties	11	2.41	3	0.86
Federal Realty Investment Trust	11	1.96	3	1.26
Ventas	11	1.85	1	1.10
Mack-Cali Realty	11	1.77	3	1.05
United Dominion Realty	11	1.72	3	1.20
Liberty Property Trust	11	1.41	3	1.42
Trizec Properties	10	1.87	2	0.82
Corporate Office Properties Trust	10	1.69	3	0.46
LaSalle Hotel Properties	10	1.38	3	0.41
Brandywine Realty Trust	10	1.21	3	0.62
Taubman Centers	10	1.08	3	0.64
Prentiss Properties Trust	10	0.78	3	0.70

The Big 20

20 Largest U.S. REIT Funds   (data as of 12/31/05)	Total Assets in all share classes   ($ mil)	Number of Portfolio Holdings	Percentage of Fund invested in Stocks Held in ALL Three REIT Indexes	Percentage of Fund or Index Invested in non-REIT Stocks   (as per Morningstar’s classification)	3 Year Annualized Return (Pre-tax)   (as of 12/31/05)
DFA Real Estate Securities (1)	1,821	129	85.2	0.7	26.54
Phoenix Real Estate Sec A	875	53	84.4	1.4	27.94
streetTRACKS WR REIT Index	--	94	--	2.0	27.26
T. Rowe Price Real Estate	962	43	87.9	3.8	28.33
Vanguard REIT Index	6,835	109	--	4.0	25.67
American Century RE Inv	1,219	56	76.4	5.2	28.12
Davis Real Estate A	634	42	80.0	6.4	27.36
Alliance Bernstein Real Estate A	786	45	80.2	6.6	27.75
Cohen & Steers Real Shares	2,042	48	80.3	7.5	29.99
Wells Fargo S&P REIT Index	339	101	--	8.0	24.27
Russell Real Estate Securities S	1,594	85	75.0	8.2	27.84
Scudder RREEF Real Estate Inst	1,320	59	76.1	8.7	27.14
Principal Inv R/E Pfd	839	42	79.5	9.1	28.64
AIM Real Estate C	1,388	70	75.2	11.2	28.45
Fidelity Real Estate Inv	5,835	51	75.9	11.2	27.27
Goldman Sachs Real Estate Ins	696	47	73.2	11.8	28.78
First American Real Estate Sec Y	659	62	66.1	13.3	28.09
Morgan Stanley Ins US R/E A	1,366	63	72.7	15.1	30.51
Franklin Real Estate Sec A	1,083	58	42.1	15.5	27.22
Alpine Realty Income & Growth Y	671	79	48.6	15.9	24.88
Columbia Real Estate Equity Z	731	39	67.6	17.2	23.95
ING Van Kampen Real Estate S	1,022	54	72.1	18.1	30.37
CGM Realty	1,030	20	52.0	33.6	48.35

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Craig L. Israelsen, Ph.D. is an associate professor at Brigham Young University. He teaches family finance in the Department of Home and Family Living. His research interests include mutual fund analysis. He writes monthly for Financial Planning magazine. Learn more about Craig Israelsen at http://familyliving.familylife.byu.edu/faculty/israelsen.htm