REIT vs other sector funds for rebalancing

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tc101
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REIT vs other sector funds for rebalancing

Post by tc101 »

Many people here recommend an allocation to the REIT fund because it behaves differently than the total stock market. One fund may go up when the other goes down and there may be a rebalancing bonus. Why are REITs better for this than the other sector funds such as Energy, Health Care, Precious Metals and Mining, or the sector specific ETFs?
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NoRoboGuy
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Re: REIT vs other sector funds for rebalancing

Post by NoRoboGuy »

Because while REITs are equity instruments, they represent holding companies for various categories of real estate. The factors driving real estate markets are distinctly different from other industries comprising the stock market: for example, land, rents, housing, timber, etc. and represent a larger part of the economy than represented by their capitalization within stock markets. The tax status of REITs requires the majority of earnings to be directly passed to shareholders. If you are considering REITs, you would need to place them in tax-advantaged accounts. Finally, not all Bogleheads will agree REITs should be a separate portfolio holding - the most common argument against is that REITs are already in the the broad market index, so adding is "tilting" much like when investors tilt to small value.

I do not hold them for a "rebalancing bonus" but for a higher risk-adjusted return. REIT's performance characteristics add diversification for me within the equity space. I also include international REITs for the same reason.
Last edited by NoRoboGuy on Fri May 17, 2013 11:42 am, edited 2 times in total.
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Re: REIT vs other sector funds for rebalancing

Post by abuss368 »

You don't need to place them in a tax advantaged account only.
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Re: REIT vs other sector funds for rebalancing

Post by NoRoboGuy »

The right word is "should" because in general they are tax-inefficient. You are correct if you mean there are exceptions. International REITs (like VNQI) and Plum Creek Timber (PCL) come to mind which have differing tax aspects. Does the foreign tax credit make it worthwhile to place VNQI in taxable? I would think not but others disagree.
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Re: REIT vs other sector funds for rebalancing

Post by rmelvey »

Lots of people are into the idea of holding the "optimal risky portfolio." With certain assumptions, this portfolio is often very close to global weighting of all assets.

However, we often use the stock market as a proxy for this "optimal risky portfolio." In reality, this optimal risky portfolio would include things like real estate, gold, and any other assets that investors hold. People use REITS as a proxy for real estate held directly, tilting towards it to get a portfolio that is more representative of the aggregate asset markets. TBH, I think the history of the tilt has a lot to do with performance chasing because RE hadn't yet had a major crash.
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Re: REIT vs other sector funds for rebalancing

Post by tc101 »

REIT's performance characteristics add diversification for me within the equity space.
I just did a comparison chart on Yahoo

It looks like Energy and Precious Metal & Mining are less correlated with the S&P 500 than REITS. It looks like Health Care is more correlated.

So if you want diversification, wouldn't Energy or Precious Metal & Mining work better?
Last edited by tc101 on Fri May 17, 2013 12:17 pm, edited 1 time in total.
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Re: REIT vs other sector funds for rebalancing

Post by zaboomafoozarg »

rmelvey wrote:TBH, I think the history of the tilt has a lot to do with performance chasing because RE hadn't yet had a major crash.
60 or 70% in 2008/9 was pretty big.
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Re: REIT vs other sector funds for rebalancing

Post by shersch »

tc101 wrote:
REIT's performance characteristics add diversification for me within the equity space.
I just did a comparison chart on Yahoo

It looks like Energy and Precious Metal & Mining are less correlated with the S&P 500 than REITS. It looks like Health Care is more correlated.

So if you want diversification, wouldn't Energy or Precious Metal & Mining work better?

Interesting. That surprises me, but I trust your efforts. One additional differentiator: Energy is already accounted for in the Vanguard Total Stock Market [as are Health Care and REITS, to be fair].

Is that a potential argument in favor of direct exposure to metals as a diversifier amidst a strategic rebalance policy?
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Re: REIT vs other sector funds for rebalancing

Post by tc101 »

Interesting. That surprises me, but I trust your efforts.
Feel free to double check me. I could have made a mistake.
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Re: REIT vs other sector funds for rebalancing

Post by rmelvey »

zaboomafoozarg wrote:
rmelvey wrote:TBH, I think the history of the tilt has a lot to do with performance chasing because RE hadn't yet had a major crash.
60 or 70% in 2008/9 was pretty big.
Oh, yes of course. I just think that tilting toward REITs was largely popular before that crisis and after the crisis the case for REITS diversification benefits appears weaker. Does anyone know at what time it started becoming kosher for indexers to carve out reits separately? It would be useful to have some historical context for the history of the tilt.
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Re: REIT vs other sector funds for rebalancing

Post by rkhusky »

There must be an equal sector weight fund out there somewhere. First Google link: http://www.alpsetfs.com/eql-index.php
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Re: REIT vs other sector funds for rebalancing

Post by azanon »

abuss368 wrote:You don't need to place them in a tax advantaged account only.
If you don't though, one is looking at the equivalent of a 1.4% expense ratio (if in the 25% tax bracket), or thereabouts, according to "table 1" at Principles of Tax-Efficient Fund Placement (boglehead wiki). That is, unless I'm interpreting that chart wrong?

I would think for a traditional boglehead, a 1.4% expense ratio, or its equivalent, would be out of the question, which is to make no mention of the actual expense ratio of the fund.
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Re: REIT vs other sector funds for rebalancing

Post by noyopacific »

tc101 wrote:Many people here recommend an allocation to the REIT fund because it behaves differently than the total stock market. One fund may go up when the other goes down and there may be a rebalancing bonus. Why are REITs better for this than the other sector funds such as Energy, Health Care, Precious Metals and Mining, or the sector specific ETFs?
I have had REIT, Energy & Health sector funds for nearly 20 years. I dropped the Vanguard Gold fund when they changed it to Precious Metals & Mining and later added Utilities after I found that the ETF: VPU was available. A prolonged run up in the Health Sector early on is what initially led me to believe I should start rebalancing annually. Then I noticed that I was getting what I eventually learned is called a rebalancing bonus. I can't claim this was what I had planned for, it was basically just an extended stroke of luck for me. My core holding has always been a broad market index fund. At first it was the S&P 500 and later changed to Total Stk Mkt. I've also kept Small Cap & International index funds in the mix. After my portfolio reached 50% of my retirement target, I moved 25% into the Total Bond Mkt fund. The portfolio is now over 90% of my retirement target. If it hits 100%, the plan is to increase the bond component to 40%.
in response to your question: "Why are REITs better for this than the other sector funds" I have been wondering for a couple of years now how much of the recent interest in the REIT sector is people that might be chasing past performance.
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Re: REIT vs other sector funds for rebalancing

Post by NoRoboGuy »

tc101 wrote:
REIT's performance characteristics add diversification for me within the equity space.
I just did a comparison chart on Yahoo

It looks like Energy and Precious Metal & Mining are less correlated with the S&P 500 than REITS. It looks like Health Care is more correlated.

So if you want diversification, wouldn't Energy or Precious Metal & Mining work better?
Low correlation is not the only consideration. As I already stated (but probably not clearly enough), the factors driving real estate markets are distinctly different from other industries comprising the stock market and real estate represents a larger part of the economy than represented by its capitalization within stock markets. That said - I do not disagree if your assertion is that overweighting Energy or Precious Metal & Mining might provide reduced portfolio volatility within the equity space.
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Re: REIT vs other sector funds for rebalancing

Post by telemark »

rmelvey wrote:
zaboomafoozarg wrote:
rmelvey wrote:TBH, I think the history of the tilt has a lot to do with performance chasing because RE hadn't yet had a major crash.
60 or 70% in 2008/9 was pretty big.
Oh, yes of course. I just think that tilting toward REITs was largely popular before that crisis and after the crisis the case for REITS diversification benefits appears weaker. Does anyone know at what time it started becoming kosher for indexers to carve out reits separately? It would be useful to have some historical context for the history of the tilt.
Bernstein's Coward's Portfolio has REIT separately and dates from 1996. The Coffeehouse Portfolio also separates REIT and dates, I think, from about the same time. So a long time before 2008.
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