Overweighting REIT: Thought Experiment

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Boglenaut
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Overweighting REIT: Thought Experiment

Post by Boglenaut »

For years, I kept a very small over-weight on REIT (VGSLX) on the theory that real-estate was under-represented in the public market.

But I thought about this more. Most professional sports teams in the US are privately owned. So they are most likely to be under-represented in my portfolio. But I would not buy publicly-owned Green Bay Packers at 31X overweight to make up for the 31 NFL teams I believe are not public.

Note: I have not watched an NFL game in 20+ years because the Big Business greed ruined it for me (but if all teams were like the publicly owned Packers I would).

Note: I am not currently overweight REITS... not because I don't buy the argument, but because I simplified my portfolio recently.
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galeno
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Re: Overweighting REIT: Thought Experiment

Post by galeno »

We too went for maximum simplification this year. We went from 6 ETFs (1 bond + 5 equity) to 2.
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Re: Overweighting REIT: Thought Experiment

Post by nisiprius »

I am still waiting for anyone to give a coherent rationale for weighting according to proportion in the economy rather than weighting according to proportion in the stock market.

This "economy thing" is weird. It is never explained or stated. Someone simply launches into an essay about how emerging markets are far more than 18% of the world economy, or how small companies that don't issue stocks are far more than 9% of the national economy or something, and then goes on to explain what you could invest in to beef up your portfolio to match the economy. You are supposed to think "it must be so obvious that it doesn't need explaining," or "everyone must already agree to this."
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Re: Overweighting REIT: Thought Experiment

Post by rapporteur »

Dear nisiprius,

Let me give you my take on why the ‘economy thing’ is NOT ‘weird’ – or at least not nearly so weird as some might think.

The CAPM, while a tremendous theoretical insight that helps us structure our approach to investing, is a very coarse first approximation to reality. If its rationale is pushed hard, many absurdities and discrepancies from reality manifest themselves.

The first point – one very often overlooked – is that the CAPM – in its fully-fledged form - is NOT just about investible financial markets (i.e., listed stocks and bonds) but about ALL capital assets. Semi-rigorously: a ‘capital asset’ is any ‘entity’ (a tangible thing, a claim or right, and on and on) that is reasonably expected to provide an income/benefit stream in the future, or – and some will, with strong arguments, demur here – with anything that can be *exchanged* for such an entity (e.g., gold bars).

This means that a ‘capital asset’ (the CA in CAPM) also includes such hard-or-impossible-to-invest-in things as private equity, public infrastructure, real estate, and human capital. IOW ALL capital assets! The CAPM is a statement about the *entirety* of such entities!

(Aside: Purchasing ‘human capital’ is an issue over which USians fought a war in 1861-1865; nowadays one can only rent human capital – that is, hire labour.)

Hence, the interest in ‘broadening’ from just ‘financial markets’ to encompass the ‘whole economy’ (and, while not raised here, to the entire world rather than just the US).

But ‘narrow' investors can take heart. One corollary of the CAPM is that any (diversified) SUBSET of ‘all capital assets’ - once adjusted for risk and other impediments such as liquidity, transaction costs, etc. – has **exactly** the same expected return as the *entire* capital asset universe! (assuming of course that we can adequately characterize and quantify risk, etc.). The CAPM implies that *everything* has the same *expected* quasi-Sharpe-ish ratio – if we could only get a handle on the right definition of the ‘risk-ish’ Sharpe divisor.

So, it’s OK to *just* invest in stocks and bonds – and *just* in the US :happy - or to lust to invest in ‘everything, everywhere’.

Regards,

PS IOW, the CAPM is not rigorously true, it’s only a coarse approximation, and we must have the good sense to use it wisely as far as it can usefully lead us, and then **put it aside**.
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Re: Overweighting REIT: Thought Experiment

Post by rustymutt »

Since last year was really good for Vanguard's REIT offerings, I'm automatically over weighted on it now. Momentum investing at work. How long will the late return chasers seek alpha with it? Who knows.
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Re: Overweighting REIT: Thought Experiment

Post by abuss368 »

galeno wrote:We too went for maximum simplification this year. We went from 6 ETFs (1 bond + 5 equity) to 2.
Hi galeno,

Interesting. Would you perhaps expand on that in terms of the prior funds and the current portfolio. We have been on the fence about additional simplicity.

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Overweighting REIT: Thought Experiment

Post by abuss368 »

nisiprius wrote:I am still waiting for anyone to give a coherent rationale for weighting according to proportion in the economy rather than weighting according to proportion in the stock market.

This "economy thing" is weird. It is never explained or stated. Someone simply launches into an essay about how emerging markets are far more than 18% of the world economy, or how small companies that don't issue stocks are far more than 9% of the national economy or something, and then goes on to explain what you could invest in to beef up your portfolio to match the economy. You are supposed to think "it must be so obvious that it doesn't need explaining," or "everyone must already agree to this."
Rick Ferri has written many excellent articles about this on his website. One can read his thoughts and strategy here: www.rickferri.com

Best.
John C. Bogle: “Simplicity is the master key to financial success."
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Re: Overweighting REIT: Thought Experiment

Post by nisiprius »

abuss368 wrote:...Rick Ferri has written many excellent articles about this on his website. One can read his thoughts and strategy here: http://www.rickferri.com ...
Please be more specific. I'm seeing nothing about this on the home page, and nothing about this on the page describing his Investment Philosophy.
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Re: Overweighting REIT: Thought Experiment

Post by Leif »

I overweight REITs to give me asset class diversification. I just look at historical class (or sub-class if you wish) covariances. While this can vary I stay with a fix set of classes to invest. I take my classes then evenly divide them up as a percentage of the equity portion of my portfolio. Recently I've been selling REITs to buy ISV and EM.
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Re: Overweighting REIT: Thought Experiment

Post by nisiprius »

rapporteur wrote:...the CAPM – in its fully-fledged form - is NOT just about investible financial markets (i.e., listed stocks and bonds) but about ALL capital assets....
Investopedia says:
DEFINITION OF 'CAPITAL ASSET PRICING MODEL - CAPM
A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.
"Securities" means investible stocks and bonds. Wikipedia says
The CAPM is a model for pricing an individual security or portfolio.
Please cite the definition that says the CAPM covers "private equity, public infrastructure, real estate, and human capital. IOW ALL capital assets."
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Re: Overweighting REIT: Thought Experiment

Post by Geologist »

nisiprius wrote:I am still waiting for anyone to give a coherent rationale for weighting according to proportion in the economy rather than weighting according to proportion in the stock market.
Even if you would want to weight according to proportion in the economy, I don't see how you could decide which public, investible companies are a suitable statistical sample of the private, non-investible portion of the economy. To take the OP's starting point, why should I believe that REIT's are giving me suitable exposure to the real estate that is not in the public market?
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Re: Overweighting REIT: Thought Experiment

Post by abuss368 »

nisiprius wrote:
abuss368 wrote:...Rick Ferri has written many excellent articles about this on his website. One can read his thoughts and strategy here: http://www.rickferri.com ...
Please be more specific. I'm seeing nothing about this on the home page, and nothing about this on the page describing his Investment Philosophy.
I believe it was a real economy portfolio article.
John C. Bogle: “Simplicity is the master key to financial success."
columbia
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Re: Overweighting REIT: Thought Experiment

Post by columbia »

I noticed that there's a thread on farmland investing.
Should we be clamoring for an ETF (FRM?) and over weight that too?
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Re: Overweighting REIT: Thought Experiment

Post by rapporteur »

Dear nisiprius,
Please cite the definition that says the CAPM covers "private equity, public infrastructure, real estate, and human capital. IOW ALL capital assets.
Pleased to oblige...

Rather than heap Pelion upon Ossa, I trust you will settle for a citation of Fama & French in their masterful The Capital Asset Pricing Model: Theory and Evidence
http://www-personal.umich.edu/~kathrynd ... French.pdf
in which they state:
For example, the CAPM says that the risk of a stock should be measured relative to a comprehensive “market portfolio” that in principle can include not just traded financial assets, but also consumer durables, real estate and human capital.
In short, the CAPM is *fully general* in its scope applying to *everything* that may be properly characterized as a 'capital asset' (for which I supplied a proposed definition, together with a recognition of stipulations and limitations that some might raise regarding that definition).

Of course, as a matter of practical convenience and tractability for analysis' sake, the scope of 'capital assets' is often narrowed to investible financial assets. F&F say as much (ibid.):
Even if we take a narrow view of the model and limit its purview to traded financial assets, is it legitimate to limit further the market portfolio to U.S. common stocks (a typical choice), or should the market be expanded to include bonds, and other financial
assets, perhaps around the world?
In short, in its full generality, the CAPM refers to *any and all* entities that meet the definition of 'capital asset'. We narrow it at the risk of obscuring or distorting its implications (a practice which, sad to say, is all too common).

Regards,
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Re: Overweighting REIT: Thought Experiment

Post by peppers »

nisiprius wrote:I am still waiting for anyone to give a coherent rationale for weighting according to proportion in the economy rather than weighting according to proportion in the stock market.

This "economy thing" is weird. It is never explained or stated. Someone simply launches into an essay about how emerging markets are far more than 18% of the world economy, or how small companies that don't issue stocks are far more than 9% of the national economy or something, and then goes on to explain what you could invest in to beef up your portfolio to match the economy. You are supposed to think "it must be so obvious that it doesn't need explaining," or "everyone must already agree to this."

viewtopic.php?f=10&t=91615

Nisi, this is Rick's "Total Economy" post. This might be what some of the others are referring to.
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Re: Overweighting REIT: Thought Experiment

Post by nisiprius »

rapporteur wrote:...Fama & French in their masterful The Capital Asset Pricing Model: Theory and Evidence
http://www-personal.umich.edu/~kathrynd ... French.pdf
in which they state:
For example, the CAPM says that the risk of a stock should be measured relative to a comprehensive “market portfolio” that in principle can include not just traded financial assets, but also consumer durables, real estate and human capital.
...
OK, thanks.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: Overweighting REIT: Thought Experiment

Post by heartandsoul »

nisiprius wrote:I am still waiting for anyone to give a coherent rationale for weighting according to proportion in the economy rather than weighting according to proportion in the stock market.
I'm still waiting for anyone to give a coherent rationale for an investor to indulge in any sort of weighting at all. To mimic market weightings is illogical if risk-adjusted expected return does not justify it, after allowing for diversification benefits. For example, the only reason I would put more money into larger cap stocks is if there was good evidence they were likely to outperform long-term. All the evidence I've seen suggests the opposite.

I would apply the same argument to weighting any assets, including REITS.
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