Larry Swedroe: REITs Aren't Special

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Random Walker
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Larry Swedroe: REITs Aren't Special

Post by Random Walker » Fri Jul 21, 2017 3:13 pm

http://www.etf.com/sections/index-inves ... nt-special

In this article Larry makes the argument that REITs don't really function as a distinct asset class. Although their correlations to stocks and bonds are fairly low, their returns are quite well explained by a six factor model including market beta, size, value, Momentum, term, credit quality.
Larry reviews an article written by two members of his firm, Jared Kizer and Sean Grover, who describe 4 criteria they believe an investment must meet to be considered a distinct asset class. They describe the criteria and why REITS fail to meet all of them. The criteria are as follows:
1. Low correlation to established asset classes
2. Significant positive alpha relative to accepted Factor models
3. Inability to be replicated on a co-movement basis with long only portfolios
4. Improved Mean-Variance frontier when added to a portfolio of established asset classes.

I think this article is important for at least a couple of reasons. First, it makes us question the use of REITS. Perhaps other potential portfolio additions are better diversifiers. Secondly, more generally, and likely more importantly, it provides a framework for us to evaluate any potential investment as an addition to our portfolios. Combine these with Larry's 5 criteria for a worthwhile factor (persistent, pervasive, robust, intuitive, investable) and one has an excellent framework for deciding whether a potential poeprtfolio addition is worthwhile.

Personally, I've exchanged REITS for alternatives discussed in other threads: AQR Style Premia, TS Momentum, Alternative Lending, Reinsurance, Risk Variance Premia.

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Re: Larry Swedroe: REITs Aren't Special

Post by nedsaid » Fri Jul 21, 2017 3:31 pm

This reflects a change of heart. REITs were once a "must have" asset class by the advocates of factor tilting. What happened is that all of the yield chasing put REIT valuations out of sight, that is, they no longer represent value. There was also rethinking about commodities, once recommended and now not recommended. Valuations were an issue here too.

The problem I am beginning to have with all of this is that academic research is starting to look faddish. You can see a lot of rethinking going on out there. A better approach to this would be to admit that valuations are out of kilter and that REITs are being put on the back burner for now until valuations are more attractive. Now they are questioning whether or not REITs are still an asset class. Pretty much, what I am hearing is that if valuations are high for an asset class, that it ceases to be an asset class. I don't go along with that line of thinking at all. What has been done here is that they can now use a factor argument rather than a valuation argument to say that REITs are no longer an asset class.

Sort of like when Pluto got demoted from being a planet. I don't buy it.
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Re: Larry Swedroe: REITs Aren't Special

Post by saltycaper » Fri Jul 21, 2017 3:36 pm

Taken from the 2008 book, The Only Guide to Alternative Investments You'll Ever Need***, authored by Larry Swedroe and Jared Kizer (co-author of the paper referenced in the article):
Swedroe and Kizer wrote:
The evidence from academic studies demonstrates that equity REITs, both domestic and international, offer an attractive risk/return trade-off and provide meaningful diversification benefits to portfolios. Thus, investors with the ability to hold equity REITs in a tax-advantaged account should consider them as a core holding, not as an alternative asset.
Oops. Guess we can add REITs to commodities, another asset class I believe Larry once recommended. I don't read everything by Larry, so I don't know if he took the time to say he was wrong, or that he changed his mind, or that new research has brought a change in recommendation, or however else one might choose to emphasize the switch and alert followers to the new approach.

I didn't bite on REITs, as the performance of small value, to which I tilt, seemed too close to bother.

I appreciate Larry's data- and evidence-based approach, but sometimes I think it goes too far, and the big picture might be lost.

***I guess the title was a bit of an exaggeration, eh?
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Re: Larry Swedroe: REITs Aren't Special

Post by zaboomafoozarg » Fri Jul 21, 2017 3:58 pm

nedsaid wrote:The problem I am beginning to have with all of this is that academic research is starting to look faddish.
Agreed. More and more I can see the appeal of just buying total market and being done with it. But I have my tilts and I'm sticking to 'em.

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Re: Larry Swedroe: REITs Aren't Special

Post by Thesaints » Fri Jul 21, 2017 4:10 pm

REIT were created in 1960 to offer investors a vehicle providing high cash flow.
Today, with transaction costs near zero and being able to sell fractional shares they have kind of survived their usefulness.

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Re: Larry Swedroe: REITs Aren't Special

Post by indexonlyplease » Fri Jul 21, 2017 4:12 pm

I am becoming burned out on tilts. they work they don't work everyone has the opinion. I guess when scv make there run someone will say I told you to tilt.

Did shakspear say to tilt or not to tilt?

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Re: Larry Swedroe: REITs Aren't Special

Post by lack_ey » Fri Jul 21, 2017 4:23 pm

nedsaid wrote:This reflects a change of heart. REITs were once a "must have" asset class by the advocates of factor tilting. What happened is that all of the yield chasing put REIT valuations out of sight, that is, they no longer represent value. There was also rethinking about commodities, once recommended and now not recommended. Valuations were an issue here too.

The problem I am beginning to have with all of this is that academic research is starting to look faddish. You can see a lot of rethinking going on out there. A better approach to this would be to admit that valuations are out of kilter and that REITs are being put on the back burner for now until valuations are more attractive. Now they are questioning whether or not REITs are still an asset class. Pretty much, what I am hearing is that if valuations are high for an asset class, that it ceases to be an asset class. I don't go along with that line of thinking at all. What has been done here is that they can now use a factor argument rather than a valuation argument to say that REITs are no longer an asset class.

Sort of like when Pluto got demoted from being a planet. I don't buy it.
The analysis is over a longer period and suggests that there was nothing really unique about the returns even through all the years when REITs were doing well.


Though notably they do not look at inflation or any macro factors. Recall that the basis for many suggested overweightings to REITs was along the lines of attempting to own more real assets, etc. People have always said that REITs have a different structure than other equities, which is still true. The relatively moderate correlation is also still true (but this needs to be considered in context with returns, value added, etc.).

There are some other caveats or concerns that could be raised, but regardless there is some interesting stuff here from the paper, like this:
Image

That is, if you regress sectors on factors, you see REITs ending up with small, value, term, and credit risk. You can just invest in those areas more directly without the explicit sector targeting. Though R^2 is still fairly low, there doesn't seem to be unique alpha from REITs above the exposures, at least for that period.

These relationships can well change to some degree, so you never know.
zaboomafoozarg wrote:
nedsaid wrote:The problem I am beginning to have with all of this is that academic research is starting to look faddish.
Agreed. More and more I can see the appeal of just buying total market and being done with it. But I have my tilts and I'm sticking to 'em.
It's not that research itself is a fad. I'd say you're thinking more about targeting investment strategy based on a slice of this kind of analysis.

There are always going to be multiple explanations, uncertainty, especially when dealing with the amount of data available (not enough), things people didn't think or realize. Evidence-based investing is an exercise in being wrong a lot of the time and changing your ideas with the times (commodities etc.). I think as long as you have reasonable expectations and understand that in a decade everybody's going to say that X thing you think now is varying degrees of incomplete or wrong, and you never got all of the theoretical benefits touted, it's okay.


Tilting is just active management where you as the overall portfolio manager are making broad decisions about portfolio composition, rather than delegating the decision to traditional active managers. You'll get a result that's different from the market, for better or worse.

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Re: Larry Swedroe: REITs Aren't Special

Post by QuietProsperity » Fri Jul 21, 2017 4:52 pm

It is true that REITs provide exposure to the Size, Value, Term, and Credit factors and can be historically (mostly) replicated via a combination of small/mid-cap value + Corporate Bonds:

See Here

It is also true, that even when replicated via factor exposure, REITs still have some level of a correlation bonus to traditional assets (Stocks & Bonds).

For those that take a Market-Cap Weighted approach (i.e. 3-Fund or something similar) I think adding an explicit REIT allocation can be useful. For those that already slice and dice, I think they can be ignored unless you want further Size+Value exposure.

Beyond gaining the extra factor exposure, I agree with Larry that there is really nothing special about REITs in adding long-term returns, but their lower correlations to stocks and bonds, which has continued, even in recent years, tells me that they should still be considered a distinct asset class. It just depends on your current choice of strategy on how useful they may be.

P.S. I hope this is simply not a change of heart due to valuations. It is hard for me to think that Larry and his firm would take that approach.

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Re: Larry Swedroe: REITs Aren't Special

Post by KlangFool » Fri Jul 21, 2017 5:13 pm

Folks,

I was investing on REIT (VGSIX). I no longer do that. The reason: REIT Privatization Wave.

http://www.nreionline.com/mag/privatiza ... hits-reits

http://www.businesswire.com/news/home/2 ... it-Foreign

Public REIT is a small segment of the overall US Real Estate. And, whenever it is profitable for someone to privatize that REIT, they do it. This happened even to the largest Public REIT. And, whenever it is more profitable to go public, they do that too. It goes in waves and we as an individual investor do not get the best end of the deal.

KlangFool

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Re: Larry Swedroe: REITs Aren't Special

Post by willthrill81 » Fri Jul 21, 2017 5:20 pm

lack_ey wrote:Tilting is just active management where you as the overall portfolio manager are making broad decisions about portfolio composition, rather than delegating the decision to traditional active managers.
I've heard this before and disagree. Active management is generally taken to mean deviating from a cap-weighted index. Just because someone is passively buying the Russell 2000 instead of TSM doesn't mean that they're actively managing their portfolio. Otherwise, someone could argue that anything other than a global cap-weighted portfolio (which virtually no one has) is active management.

Further, most active managers I've seen are largely making decisions about which specific stocks to purchase within a particular asset class (i.e. large cap), not determining which asset classes (i.e. LCV, SCV) they're going to buy.
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Re: Larry Swedroe: REITs Aren't Special

Post by Dead Man Walking » Fri Jul 21, 2017 5:26 pm

nedsaid wrote:This reflects a change of heart. REITs were once a "must have" asset class by the advocates of factor tilting. What happened is that all of the yield chasing put REIT valuations out of sight, that is, they no longer represent value. There was also rethinking about commodities, once recommended and now not recommended. Valuations were an issue here too.

The problem I am beginning to have with all of this is that academic research is starting to look faddish. You can see a lot of rethinking going on out there. A better approach to this would be to admit that valuations are out of kilter and that REITs are being put on the back burner for now until valuations are more attractive. Now they are questioning whether or not REITs are still an asset class. Pretty much, what I am hearing is that if valuations are high for an asset class, that it ceases to be an asset class. I don't go along with that line of thinking at all. What has been done here is that they can now use a factor argument rather than a valuation argument to say that REITs are no longer an asset class.

Sort of like when Pluto got demoted from being a planet. I don't buy it.
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Re: Larry Swedroe: REITs Aren't Special

Post by lack_ey » Fri Jul 21, 2017 6:53 pm

willthrill81 wrote:
lack_ey wrote:Tilting is just active management where you as the overall portfolio manager are making broad decisions about portfolio composition, rather than delegating the decision to traditional active managers.
I've heard this before and disagree. Active management is generally taken to mean deviating from a cap-weighted index. Just because someone is passively buying the Russell 2000 instead of TSM doesn't mean that they're actively managing their portfolio. Otherwise, someone could argue that anything other than a global cap-weighted portfolio (which virtually no one has) is active management.

Further, most active managers I've seen are largely making decisions about which specific stocks to purchase within a particular asset class (i.e. large cap), not determining which asset classes (i.e. LCV, SCV) they're going to buy.
It's active in the sense of having active share against the total market benchmark. Or active in the sense of making macro asset allocation decisions against the market. It's not active in the sense of bottom-up discretionary securities analysis, which is what most people think about traditionally. But there are plenty of "global macro" asset allocators that people would agree are active.

It used to be that you had to go to discretionary, traditional active managers to get targeted factor exposure, but it's generally not been the case for decades now. Regardless, the decision to deviate from the market in search of some other properties and behavior is the same as before, whether you're doing so via actively managed mutual funds, or some other structures. You have to analyze potential benefit vs. cost.

I use the term just to emphasize that any time you deliberately decide to overweight something, taking more of A and less of B, you have to justify it and live with whatever returns you get relative to the market.

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Re: Larry Swedroe: REITs Aren't Special

Post by iamlucky13 » Fri Jul 21, 2017 6:57 pm

Larry's articles tend to be a little bit above my level of financial education, so again here, I'm not clear why I should care whether REIT's fit a specific technical definition of an asset class - or even why being able to replicate them with a mix of two existing asset classes (heavily tilted) is a useful criteria for defining them.

I do care about diversification, and since the research he is reporting on does seem to indicate a relatively low correlation with stocks and bonds, it seems like a potentially useful tool to smooth out value fluctuations. How much I would want in my portfolio as a result, I'm not sure, but the overall takeaway from the article seem to me to be not to avoid REIT's, but rather not to put too much into them.

After all, he said REIT's aren't special, not that they aren't worthwhile in some form.

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Re: Larry Swedroe: REITs Aren't Special

Post by lack_ey » Fri Jul 21, 2017 8:18 pm

iamlucky13 wrote:Larry's articles tend to be a little bit above my level of financial education, so again here, I'm not clear why I should care whether REIT's fit a specific technical definition of an asset class - or even why being able to replicate them with a mix of two existing asset classes (heavily tilted) is a useful criteria for defining them.

I do care about diversification, and since the research he is reporting on does seem to indicate a relatively low correlation with stocks and bonds, it seems like a potentially useful tool to smooth out value fluctuations. How much I would want in my portfolio as a result, I'm not sure, but the overall takeaway from the article seem to me to be not to avoid REIT's, but rather not to put too much into them.

After all, he said REIT's aren't special, not that they aren't worthwhile in some form.
His definition of an asset class is not widely accepted, so it doesn't even really matter outside the scope of the article. For our purposes it's just a defined term for the sake of the explanation there.

Low correlation in of itself does not indicate useful diversification, and some other sectors also have relatively moderate correlation with the broad equity market too.

But regardless, your takeaway is fine under the premise of the article. The (excess returns, academic) factor-centric perspective would be to get the exposure and effect via other means rather than explicitly overweighting REITs, but if you prefer using a REIT fund then that should be fine too, though maybe less justified within that framework.

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Re: Larry Swedroe: REITs Aren't Special

Post by thx1138 » Fri Jul 21, 2017 8:45 pm

saltycaper wrote:Taken from the 2008 book, The Only Guide to Alternative Investments You'll Ever Need***, authored by Larry Swedroe and Jared Kizer
***I guess the title was a bit of an exaggeration, eh?
I learned awhile back that non-fiction authors often don't get to chose the title for their own books! Usually it is the publishers that come up with these ridiculous titles. I know Larry has commented in the past he often doesn't get to chose the title to his books.

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Re: Larry Swedroe: REITs Aren't Special

Post by nisiprius » Fri Jul 21, 2017 8:58 pm

saltycaper wrote:Taken from the 2008 book, The Only Guide to Alternative Investments You'll Ever Need***, authored by Larry Swedroe and Jared Kizer (co-author of the paper referenced in the article):
Swedroe and Kizer wrote:The evidence from academic studies demonstrates that equity REITs, both domestic and international, offer an attractive risk/return trade-off and provide meaningful diversification benefits to portfolios. Thus, investors with the ability to hold equity REITs in a tax-advantaged account should consider them as a core holding, not as an alternative asset.
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Re: Larry Swedroe: REITs Aren't Special

Post by stlutz » Fri Jul 21, 2017 9:23 pm

I think it's unfortunate that the authors of the paper (from Swedroe's firm) combined the questions of a) whether REITs are a separate asset class and b) whether they are an attractive security to own. The implication they give is that if they found REITs to be attractive, well then they would be a distinct asset class. The analysis they did on whether REITs are an asset class is quite interesting and adds to the discussion.

Pretty much everyone agrees that making loans (e.g. by buying bonds, CDs etc) is completely different from buying stocks in businesses. If a business is making loans (i.e. a bank), buying that business is a "stock" and not a "bond."

Commercial real estate itself is most certainly a distinct asset class from stocks and bonds. But what if I turn a portfolio of commercial real estate holdings into a publicly traded security that is just like a stock in every way except the way it is taxed? Does it become a "stock" or is it "real estate?"

I've always argued the former. I like this paper because it supports my point of view. :D Mathematically, REITs don't act any differently from any other sector-based sliced of the stock market. There doesn't seem to be much in the way of distinct risk factors in REITs that don't otherwise exist in the stock market. I did find that bit of analysis to be interesting.

Unfortunately, the paper then goes down the road of "proving" that smallcap value is superior to every other sub-slice of the equity market, and thus the conclusion is that there is no point in owning any equities aside from smallcap value. And because of this, REITs are not an asset class. In my own view, whether SV is the best has absolutely nothing to do with the uniqueness of REITs.

In fairness to Swedroe, he was never a huge REIT fanboy. I think in his 1998 book he argued for up 10% of one's equity allocation to REITs, which was pretty conservative back then. That's not a huge deviation from market weight which is, I believe, something like 4%. In recent years Swedroe has switched to advocating 0% based on his approach of using valuation-based tactical asset allocation. But at the end of the day, whether one has 0%, 4%, or 10% of their equities in REITs isn't going to make that big of a difference. The demonstration that REITs are not a unique asset class should at least dissuade one from putting, say, 1/3 of their equities into REITs. And that is the real value of the paper.

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Re: Larry Swedroe: REITs Aren't Special

Post by nedsaid » Fri Jul 21, 2017 9:25 pm

For the record, I cut back my REITs by 20% and am not adding more. Partly because of the warnings issued by Bill Bernstein and Larry Swedroe, I cut back. All the yield chasing has changed things.

I am of the opinion that you need to adjust to economic and market realities. Last I read, REITs were very richly valued and had very low future expected returns. REITs have also been a very volatile asset class. In the case of commodities, these markets last I read, were in contango. The money that flooded into commodities from institutional investors changed the commodity markets. So Larry and Bill are rational to change their minds when the facts change.

But true to my belief that I could be wrong, I have not exited REITs. I have never invested in commodities.
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Re: Larry Swedroe: REITs Aren't Special

Post by nedsaid » Fri Jul 21, 2017 9:35 pm

Another thing to keep in mind is that there has been in the past a lot of overlap between REITs and Small Value. This contributes to Larry's questioning of REITs as an asset class. One of the criticisms of Vanguard Small Value Index was that it did not screen out REITs. As I recall, the DFA Small Value fund did screen out REITs and thus was favored by financial advisors over the Vanguard Small Value Index fund.

The Vanguard REIT Index ETF has drifted from Small/Mid Value to Small/Mid Core. In fact, this ETF is close to Small/Mid Growth. This shows the effect from yield chasing. It seems to me that the REIT Index is more Mid-Cap and less Small-Cap than it used to be. Thus the REIT Index/Small-Cap overlap is less than it used to be. Can someone put numbers to this?
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Re: Larry Swedroe: REITs Aren't Special

Post by siamond » Fri Jul 21, 2017 10:21 pm

Stay the course... How simple and yet tremendously challenging those 3 simple words are... :shock:

I have 10% REITs, I really do not know if that was a good idea or not, but I'll stick to it. Or at least try my best. And forget about factor#4 or #5 or #6 or whatever...

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Re: Larry Swedroe: REITs Aren't Special

Post by Svensk Anga » Fri Jul 21, 2017 10:26 pm

nedsaid wrote: As I recall, the DFA Small Value fund did screen out REITs and thus was favored by financial advisors over the Vanguard Small Value Index fund.
DFA screening out REITS was my recollection as well. Swedroe I think prefers the DFA funds. If he is also foregoing a specific allocation to REITS, he is making a decision to deliberately avoid investing in one segment of the equity market. So that is foregoing maximum diversification.

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Re: Larry Swedroe: REITs Aren't Special

Post by BogleMelon » Fri Jul 21, 2017 10:41 pm

Every time one of these articles is getting published i feel relieved as I don't really have to understand all the technicalities in the article or best I don't have to worry about my portfolio. Again I feel my 3 fund portfolio has scored another home run! Thanks to this forum though! Yes simplicity wins!
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Re: Larry Swedroe: REITs Aren't Special

Post by bigred77 » Fri Jul 21, 2017 10:42 pm

This is one of the few articles of Larrys that I really don't buy.

There's an awful lot of data mining and subjective definitions going on there IMO.

Are SCV and LT Corp Bonds distinct asset classes or are they part of larger distinct asset class (equities and fixed income)? If SCV is distinct then REITs are DEFINITELY distinct in my mind.

At the end of the day, I want to put my money into ownership stakes of business, loan money to a variety of entities, and own Real Estate. If not REITs, how does one passively invest in Real Estate?

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Re: Larry Swedroe: REITs Aren't Special

Post by stlutz » Fri Jul 21, 2017 10:55 pm

If not REITs, how does one passively invest in Real Estate?
You can't--at least not easily--and that includes REITs. REITs are to real estate what banks are to fixed income--they are in the business, but buying those stocks is not the same thing as engaging in the underlying activities (renting property or making loans) yourself.

REITs are stocks, not real estate. That doesn't make them bad. It just means there is no obvious case for holding some outsized position in your portfolio.

If you want to diversify into real estate, you need to do that by buying properties on your own. If you want to be more passive, hire a management company to handle most of the work for you.

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Re: Larry Swedroe: REITs Aren't Special

Post by stlutz » Fri Jul 21, 2017 10:58 pm

Are SCV and LT Corp Bonds distinct asset classes or are they part of larger distinct asset class (equities and fixed income)? If SCV is distinct then REITs are DEFINITELY distinct in my mind.
They weren't arguing that SCV and LT Corp. bonds are distinct asset classes. Rather, they were arguing that REITs act very similarly to a portfolio of SCV and LT Corp., meaning that there isn't in fact anything particularly unique about REITs.

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Re: Larry Swedroe: REITs Aren't Special

Post by bigred77 » Fri Jul 21, 2017 11:07 pm

stlutz wrote:
If not REITs, how does one passively invest in Real Estate?
You can't--at least not easily--and that includes REITs. REITs are to real estate what banks are to fixed income--they are in the business, but buying those stocks is not the same thing as engaging in the underlying activities (renting property or making loans) yourself.

REITs are stocks, not real estate. That doesn't make them bad. It just means there is no obvious case for holding some outsized position in your portfolio.

If you want to diversify into real estate, you need to do that by buying properties on your own. If you want to be more passive, hire a management company to handle most of the work for you.
Its close enough for me. I can convince myself that I have "exposure" to real estate and go on about my day.

It might not be universally accepted by the pros and academics, but it's a distinct asset class to me.

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Re: Larry Swedroe: REITs Aren't Special

Post by bigred77 » Fri Jul 21, 2017 11:17 pm

stlutz wrote:
Are SCV and LT Corp Bonds distinct asset classes or are they part of larger distinct asset class (equities and fixed income)? If SCV is distinct then REITs are DEFINITELY distinct in my mind.
They weren't arguing that SCV and LT Corp. bonds are distinct asset classes. Rather, they were arguing that REITs act very similarly to a portfolio of SCV and LT Corp., meaning that there isn't in fact anything particularly unique about REITs.
Well they used the term "distinct" asset class when referring to the question of REITs and "established" asset classes when referring to SCV and Corporates. Then didn't define those terms so I have some issue with that.

Second, that looks an awful lot like data mining to me (as well as at least a partly arbitrary criteria they put forth). I'll bet if I looked hard enough I could find a combination of short term treasuries and utilities that have a 0.7 correlation to equities over some arbitrary time frame. I still wouldn't make any strong statements about equities if I did.
Last edited by bigred77 on Fri Jul 21, 2017 11:45 pm, edited 1 time in total.

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Re: Larry Swedroe: REITs Aren't Special

Post by packer16 » Fri Jul 21, 2017 11:20 pm

The issue brought up here is where the factor train has gone off the track. Factors are not underlying characteristics of businesses but instead characteristics of securities which have outperformed in the past. They are emperically derived so they do not need to be tied to fundamentals. These characteristics can change for a given security over time a value stock can become a growth stock and vise versa. The issue here is selecting factors based upon what has worked in the past. This is analogous to selecting managers in the same way and IMO will result in the same result, underperformance going forward.

Another issue is the statistical tools used to derive factors are the same as used to determine constant factors or relationships in real science. The big difference in factor estimation is that investing in a way to take advantage of a factor can reduce the factors strength versus in real science that is not the case.

So what you have an approach that appears scientific but it is another way to actively manage portfolio and make bets on which factors will do best next.

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Re: Larry Swedroe: REITs Aren't Special

Post by saltycaper » Fri Jul 21, 2017 11:28 pm

thx1138 wrote:
saltycaper wrote:Taken from the 2008 book, The Only Guide to Alternative Investments You'll Ever Need***, authored by Larry Swedroe and Jared Kizer
***I guess the title was a bit of an exaggeration, eh?
I learned awhile back that non-fiction authors often don't get to chose the title for their own books! Usually it is the publishers that come up with these ridiculous titles. I know Larry has commented in the past he often doesn't get to chose the title to his books.
Yes. Now that you mention it, I do recall Larry saying something about that. Perhaps it was a low blow. Still, I would appreciate it if some of the more widely followed authors would periodically reflect on and share where they've been and where they are now in their investment philosophies and recommendations so we can better understand how and why their views have changed and how they got to where they are today. Maybe Larry has done this and I just missed it.
"I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." --Alan Greenspan

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Re: Larry Swedroe: REITs Aren't Special

Post by raven15 » Fri Jul 21, 2017 11:41 pm

Funnily, anyone who spends a small amount of time backtesting can come to the same conclusion as this paper pretty easily. I reached this conclusion (that REIT's are 95% not special) about six months after I learned that a mutual fund was a thing. Not coincidentally, I don't explicitly invest in REIT's.
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Re: Larry Swedroe: REITs Aren't Special

Post by Random Walker » Fri Jul 21, 2017 11:49 pm

I think the takeaway is really essentially the same as the takeaway from Larry's Only Guide to Factor Based Investing. One should consider viewing diversification from a different perspective. Rather than viewing a portfolio as #stocks, bonds, geographies, the individual should consider his portfolio as a collection of factors known to drive returns. Currently well established factors that explain I believe more than 95% of a portfolio's returns include market beta, size, value, Momentum, profitability/quality, term, credit. All this article is saying is that the returns of REITs are explained by the underlying factors. Certainly REITs are one way to gain this factor exposure, but perhaps there are more efficient ways for the portfolio designer to gain access to the same factors.
REITs are tax inefficient. In our efforts to improve portfolio efficiency, there are newly available likewise tax inefficient investments that likely mix better with our long equity based portfolios than REITs. Moreover if we want to replace REITs, we can do so with more SV, term, credit exposure.

Dave

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Re: Larry Swedroe: REITs Aren't Special

Post by SimpleGift » Sat Jul 22, 2017 12:00 am

stlutz wrote:REITs are stocks, not real estate. That doesn't make them bad. It just means there is no obvious case for holding some outsized position in your portfolio.
REITs are indeed stocks. And though REITs and stocks may be correlated in the short term (i.e., correlation of monthly returns), they each have different long-term drivers of return, in my view — which is what should matter for long-term investors. REIT returns are fundamentally driven by local supply and demand factors in the real estate market, while broad market stock returns are increasingly being driven by factors in the global business cycle — which are generally (but not always) two different things.

As a result, the average correlation between REITs and the broader stock market tends to decrease with time:
While the correlation between REITs and private real estate tends to increase with time (as appraisal mis-pricings and other market pricing errors are corrected):
This indicates to me that REITs behave more like real estate than stocks for the long-term, buy-and-hold investor. Personally, I’m still holding onto my modest (10%) portfolio allocation to REITs.
Cordially, Todd

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Re: Larry Swedroe: REITs Aren't Special

Post by Longtermgrowth » Sat Jul 22, 2017 12:13 am

Random Walker wrote: Personally, I've exchanged REITS for alternatives discussed in other threads: AQR Style Premia, TS Momentum, Alternative Lending, Reinsurance, Risk Variance Premia.
Dave
I remember looking into Reinsurance after reading some of Mr. Swedroe's articles about it, but it seems not too easily accessible to the individual investor without an advisor, and not appropriate for taxable either? Are any of the alternatives accessible in a taxable self directed account?

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Re: Larry Swedroe: REITs Aren't Special

Post by Random Walker » Sat Jul 22, 2017 12:19 am

I think those who are asserting that Larry has reversed course on REITs are missing the consistency of Larry's larger message. Larry is a huge believer in (mostly) efficient markets, passive low cost investing, maximizing portfolio efficiency. As academic financial knowledge evolves and as new worthwhile investable vehicles become available, Larry's recommendations will change. This does not reflect someone changing recommendations based on current fad or valuations. Rather, it reflects someone consistently incorporating new information and new vehicles into a sound, principled, fundamental investing philosophy.
With regard to costs, cheaper is always better. But Larry has consistently looked not just at cost alone, but mainly at cost per unit value added. Thus some of his most recent recommendations of some pretty wild stuff by 3 Fund TSM standards. With regard to REITs, he is only pointing out that underlying factors explain their returns. Now since we all have real portfolios with real implementation issues, especially regarding tax advantaged space, I can see him making specific recommendations to exclude REITs or CCFs in favor of something else; and probably doesn't hurt to go against the wind of valuations.

Dave

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Re: Larry Swedroe: REITs Aren't Special

Post by Random Walker » Sat Jul 22, 2017 12:25 am

Longtermgrowth,
I only know of the one reinsurance fund. Think I've heard from others on this board that access can be bought very cheaply. I believe the AQR TS Momentum and AQR Style Premia funds don't require advisor. With regard to tax efficiency, I don't think it's black and white. These alternatives have pre tax equity like returns, about half the SD, and uncorrelated to stocks and bonds. So probably not a good idea to add them in taxable account if replacing equities. But if replacing Muni bonds, then you are increasing risk (but very different kind / diversified) and expected return.

Dave

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Re: Larry Swedroe: REITs Aren't Special

Post by White Coat Investor » Sat Jul 22, 2017 3:14 am

[quote="nedsaid"
The problem I am beginning to have with all of this is that academic research is starting to look faddish. You can see a lot of rethinking going on out there. ...I don't buy it.[/quote]

I'm skeptical as well. The data doesn't rise to the level of the data in medicine, much less the data in physics. Still lots of art to investing. It's still good to know what the data shows, but you have to realize the limitations of retrospective data.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Re: Larry Swedroe: REITs Aren't Special

Post by White Coat Investor » Sat Jul 22, 2017 3:16 am

stlutz wrote:
If not REITs, how does one passively invest in Real Estate?
You can't--at least not easily--and that includes REITs. REITs are to real estate what banks are to fixed income--they are in the business, but buying those stocks is not the same thing as engaging in the underlying activities (renting property or making loans) yourself.

REITs are stocks, not real estate. That doesn't make them bad. It just means there is no obvious case for holding some outsized position in your portfolio.

If you want to diversify into real estate, you need to do that by buying properties on your own. If you want to be more passive, hire a management company to handle most of the work for you.
Syndicated/crowdfunded properties and funds, usually for accredited investors only. Not much more hassle to buy than VGSIX, but far less liquid.
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Re: Larry Swedroe: REITs Aren't Special

Post by nedsaid » Sat Jul 22, 2017 3:52 am

Articles like this get me stirred up because I feel like a defender of factor investing and non-correlating asset classes only to see an admired proponent like Larry Swedroe start changing definitions of such things as asset classes. He then uses a factor argument about REITs rather than just out and saying that REITs are overvalued and will deliver meager future returns. It also seems like a clever way of covering his tracks, new research and all of that.

Again, what Larry should be saying is that REITs are an asset class but he is putting them on the shelf for now because of valuation concerns. Instead, he says that REITs never really were an asset class and they aren't special. To me it's like the Pope (Larry) isn't Catholic anymore. I don't like the feel of the ground shifting under my feet.

The reason this stirs me up emotionally is that I just refuse to get whipsawed every time I read an article. I cut back on REITs but I did not abandon them. Why? Expensive REITs could get even more expensive! REITs often are not correlated to the stock market so I have a good chance of getting a diversification benefit even if their future returns might be low compared to returns achieved in the past. In other words, I am hedging against the possibility that I am wrong about REIT valuations. Maybe the yield chasers will decide to chase yields even harder.

What I am trying to say is that all good investment approaches will have their day. If your portfolio is factor tilted, you are probably best off remaining factor tilted. Markets have cycles. Just as you give up on your chosen strategy in utter disgust, that is pretty much when it starts working again. If you change strategies and sell investments whenever you read an article about investing, you will be set up for perpetual disappointment. When Larry Swedroe finally throws in the towel and tells us to embrace the three fund portfolio and tearfully confesses that he never really believed what he wrote in his recent book on factor investing, that is the precise time that factors will return with a vengeance. As of now, "Pope" Larry the First is still (mostly) Catholic.
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Re: Larry Swedroe: REITs Aren't Special

Post by nedsaid » Sat Jul 22, 2017 4:02 am

indexonlyplease wrote:I am becoming burned out on tilts. they work they don't work everyone has the opinion. I guess when scv make there run someone will say I told you to tilt.

Did shakspear say to tilt or not to tilt?
To tilt, or not to tilt. That is the question.
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Re: Larry Swedroe: REITs Aren't Special

Post by Robert T » Sat Jul 22, 2017 4:47 am

.
Generally agree with the article – as per earlier post on the subject: viewtopic.php?p=3453213#p3453213
Bottom line

Adding REITs to a portfolio with similar tilts to size and value has added no/little diversification benefit (even though about half the variation in REITs returns were not explained by variations in the equity, size, and value premiums – the ‘unexplained’ variation did not provide any/much meaningful diversification benefit – at least in the two examples above).

I would just note that the result is likely different if adding REITs to a market portfolio with no tilt to smaller caps or value stocks. The diversification benefit of REITs would likely be from its size and value tilts.
One area the article could have given more attention to is the explanatory power of the models – IMO this is as important as ‘alpha’ (the metric the paper seems to focus more on). Low explanatory power suggests a large variation in returns are not explained by the variation in factors used in the paper – this residual variation (about half of the total variation in the case of REITs) is the source of any diversification benefit. Interestingly, adding the fixed income factors lowered the explanatory power for REITs.

Indeed, low explanatory power was used in this earlier 1997 piece (20 years ago) by Fama Jr https://www.ifa.com/media/images/pdf%20 ... e_fund.pdf . I agree with his focus on low explanatory power – but have not managed to get as low an R^2 as he got on any REITs series I use. In addition, he seemed to gloss over gold in Exhibit 1 in the above link which has a lower R^2 than REITs – so the article came across as more of a sales pitch for the DFA Real Estate Securities Fund. The focus on explanatory power is essentially the same/similar to the question on whether any combination of investments can approximate the risk/return characteristics.

I also recall Fama Jr’s earlier article on What Makes an Asset Class where he indicates that industries are not asset classes https://www.ifa.com/articles/What_Makes_an_Asst_Class/
After all, industries drift in and out of asset classes. They get bigger and smaller, healthier and more distressed through time. Tech stocks might be growth stocks today, but further earnings disasters could sweep them into the value category. Sorting stocks on secondary criteria like industries can therefore cause a portfolio to drift across asset classes.”
I don’t think REITs are the exception – while on average over time they have tended to be smaller cap and value stocks, over shorter time frames REITs (or at least some of them) have drifted between value and growth. For example the REIT content of Vanguard Mid-Cap Value used to be about 12 percent, but today it is about 4 percent, while in Vanguard Mid-Cap Growth is was very low, but today has increased to about 10 percent.

Currently my global portfolio REIT allocation is about 5 percent held as part of broader (value) funds, not as a separate fund, but the previous time I checked it was just over 7 percent. So it seems as REIT valuations rise (become more ‘growth oriented’) they ‘migrate’ out of my portfolio, and as they fall (become more ‘value oriented’) they ‘migrate’ back into my portfolio (value funds). This is not the case with a separate fixed allocation to REITs (as per the 10% fixed REIT allocation in the DFA Balance Strategy sample portfolios – where REITs are exclude/screened out of their value funds).

Robert
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Re: Larry Swedroe: REITs Aren't Special

Post by packer16 » Sat Jul 22, 2017 6:06 am

One risk factor I think alot of factor advocates miss is timing risk. Adding these to your portfolio with no apparent increase in expected return increases risk with no concurrent benefit. My concern is the factors are not fundamentally derived from cash flows but empirically derived from past returns which is not repeated in the future because the factors (with the exception of beta) do not provide more expected return. That is the reason these suggestions change all the time & will in the future. What factors tell you is not some fundamental ways that securities are and will be priced in the future but how they were priced in the past & in pretty much all cases will not be priced in the future.

What I find misleading is the label that somehow this is scientific & this enhances its creditability of estimating forward expected returns. This is what has happened in the past & every person acting on this is changing how security prices will be valued going forward. Thus this is much more analogous to active investing & arbing security prices to fundamental value & influencing the future returns of this strategy than simple indexing stocks vs. bonds.

I also find misleading the diversification argument. Adding factors (which are changing over time) adds risk versus reducing it because adding factors adds timing risk with IMO a question mark about adding expected value. The only factor that consistently adds value is beta, the others are more cyclical than directional. For example, If you look at the historical data on SCV vs. S&P500 what you see is cyclicality not directionality especially as more money is invested in SCV. So IMO REITs are different because there returns & cash flows are derived from a different source than stocks & these sources do not change over time, however, factors are not special (except beta) because the returns are not from a different fundamental source of cash flows, the returns are cyclical and not directional and they change all the time. What you are doing with factors is guessing who the market will crown as the fairest of them all.

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Re: Larry Swedroe: REITs Aren't Special

Post by james22 » Sat Jul 22, 2017 6:56 am

nedsaid wrote:I am of the opinion that you need to adjust to economic and market realities.
Market timer!
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Re: Larry Swedroe: REITs Aren't Special

Post by james22 » Sat Jul 22, 2017 7:12 am

I target 15% "quasi-commodities" (5% each REITS, PM&M, and Energy), so I'm curious the findings here.

If I can identify the sector factor risks, maybe I can more efficient my portfolio by directly targeting them.

But it seems there is something missing in describing assets only by factor analysis:

A large body of evidence suggests that an investor wishing to diversify their portfolio would do well to add developed international and emerging market equities.

Why would I add INTL and EM if I can explain their returns by factor analysis and better it with SV?
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Re: Larry Swedroe: REITs Aren't Special

Post by tomander » Sat Jul 22, 2017 7:38 am

packer16 wrote:The issue brought up here is where the factor train has gone off the track. Factors are not underlying characteristics of businesses but instead characteristics of securities which have outperformed in the past. They are emperically derived so they do not need to be tied to fundamentals. These characteristics can change for a given security over time a value stock can become a growth stock and vise versa. The issue here is selecting factors based upon what has worked in the past. This is analogous to selecting managers in the same way and IMO will result in the same result, underperformance going forward.

Another issue is the statistical tools used to derive factors are the same as used to determine constant factors or relationships in real science. The big difference in factor estimation is that investing in a way to take advantage of a factor can reduce the factors strength versus in real science that is not the case.

So what you have an approach that appears scientific but it is another way to actively manage portfolio and make bets on which factors will do best next.

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Re: Larry Swedroe: REITs Aren't Special

Post by DaufuskieNate » Sat Jul 22, 2017 8:28 am

Whether or not you think that REITs are an industry classification or a separate asset class, it is useful to know what the total REIT exposure is in your portfolio. This is especially true if you have a SCV tilt to begin with and what funds you use to achieve that tilt. For example, Vanguard TSM (VTSAX) has around a 3-4% exposure to REITs, but the Vanguard SCV fund (VSIAX) has 11% in REITs. Small cap dividend funds can have even larger REIT exposures. WisdomTree's SC dividend fund (DES) has 15% in REITs. Useful information, especially if you want to add additional REIT exposure with a dedicated REIT fund. Funds that screen out REITs, like those from DFA and Bridgeway, allow you to dial in and re-balance your REIT exposure with a dedicated fund.

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Re: Larry Swedroe: REITs Aren't Special

Post by grok87 » Sat Jul 22, 2017 8:40 am

QuietProsperity wrote:It is true that REITs provide exposure to the Size, Value, Term, and Credit factors and can be historically (mostly) replicated via a combination of small/mid-cap value + Corporate Bonds:
thanks.

3 quick thoughts:

1) I wonder if there is a tax angle that is being ignored here. some of reits return would be in the form of capital appreciation (perhaps not a lot) whereas for corporate bonds none of it would be.

2) i personally follow swensen and avoid corporate bonds. so replacing reits with sv + Corporate bonds wouldn't work for me

3) i wonder if some of this is due to favorable default experience for corporate bonds during the period studied.
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Re: Larry Swedroe: REITs Aren't Special

Post by blevine » Sat Jul 22, 2017 8:52 am

May not be their own asset class, but they are treated differently for tax reasons. Hence getting exposure in a traditional fund mixed tax favored and penalized assets together. I have not gone for sector funds, except reit due to ability to concentrate my reits in tax def, and other stocks in taxable. Otherwise I consider them just another equity sector.

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Re: Larry Swedroe: REITs Aren't Special

Post by AlohaJoe » Sat Jul 22, 2017 8:57 am

nedsaid wrote:Articles like this get me stirred up because I feel like a defender of factor investing and non-correlating asset classes only to see an admired proponent like Larry Swedroe start changing definitions of such things as asset classes. He then uses a factor argument about REITs rather than just out and saying that REITs are overvalued and will deliver meager future returns. It also seems like a clever way of covering his tracks, new research and all of that.
I think part of the issue is that Swedroe isn't a pure factor believer. If you believe in factors then there's really no such thing as "asset classes". Assets are just bundles of factors.

I don't think valuation has anything to do with the paper's finding. (Maybe Swedroe is conflating the two issues but the paper definitely doesn't.)

Read through that lens, this article is just saying "yup, that holds for REITs, too, just like any other sector. Their special legal structure doesn't change anything."

That strikes me as a perfectly reasonable investing framework. But then there's little room for things like reinsurance and alternative lending because there's no research whatsoever establishing they have alpha in any of the well known factor frameworks.

It would be weird to hold REITs to one standard but not your other investments. (That said, even Jack Bogle uses active mutual funds so maybe absolute purity of philosophy is impossible to maintain.)

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Re: Larry Swedroe: REITs Aren't Special

Post by Top99% » Sat Jul 22, 2017 9:50 am

REITs may or may not be a separate asset class but their valuations certainly can move somewhat independently from TSM. In the late 1990s/early 2000s they were incredibly cheap (yields of 7-10% were common) and did most of the heavy lifting for my portfolio from the late 1990s to 2008 or so. They are special to me for that reason :beer . Now as mentioned earlier in this thread yield chasing has driven valuations through the roof. I have tilted away from them (basically back to market weight) but if/when they get cheap again (IE yields 2-3x dividends for TSM) I would certainly buy more. Queue the market timing police in 3-2-1.
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Re: Larry Swedroe: REITs Aren't Special

Post by 2pedals » Sat Jul 22, 2017 9:59 am

nedsaid wrote:
indexonlyplease wrote:I am becoming burned out on tilts. they work they don't work everyone has the opinion. I guess when scv make there run someone will say I told you to tilt.

Did shakspear say to tilt or not to tilt?
To tilt, or not to tilt. That is the question.
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