Should REITs and BDCs be looked at more like bonds?

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ChinchillaWhiplash
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Should REITs and BDCs be looked at more like bonds?

Post by ChinchillaWhiplash » Sat May 26, 2018 9:10 am

Seems like these asset classes are more like bonds with their business structure and having to pay out at least 90% of profits back to shareholders as dividends. If not, they certainly should not be looked at quite the same as a standard common stock, should they?

dbr
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Re: Should REITs and BDCs be looked at more like bonds?

Post by dbr » Sat May 26, 2018 9:12 am

No, not bonds, not even close.

Whether or not common stocks of a REIT are enough different from common stocks in other corporations to classify as a different asset class has been discussed in many threads that you can look up.

BDCs .... ?

alex_686
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Re: Should REITs and BDCs be looked at more like bonds?

Post by alex_686 » Sat May 26, 2018 9:17 am

Business Development Company (BDC) develop companies. As such they are more like mutual funds.

Both REITs and BDC act more like equities. They have similar volatility and returns.

zengolf2011
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Re: Should REITs and BDCs be looked at more like bonds?

Post by zengolf2011 » Sat May 26, 2018 10:11 am

Most portfolios rely on bonds to provide safety and reduce volatility. REITs and BDCs provide neither. I think that they are sensitive to interest rates (as are bonds), but are higher-risk, possibly higher-reward investments. They perhaps share some characteristics of high-yield bonds, but may not be well-suited for most portfolios.

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Re: Should REITs and BDCs be looked at more like bonds?

Post by alex_686 » Sat May 26, 2018 10:15 am

zengolf2011 wrote:
Sat May 26, 2018 10:11 am
Most portfolios rely on bonds to provide safety and reduce volatility. REITs and BDCs provide neither.
I would contest that for REITs, but it is a debated point here. REITs have the same level or return and volatility as the overall market. However, for a asset to reduce volatility it does not have to have low volatility. It can actually even have higher volatility. What it needs is a low correlation with the other asset classes in the portfolio.

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nisiprius
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Re: Should REITs and BDCs be looked at more like bonds?

Post by nisiprius » Sat May 26, 2018 10:57 am

The blue line shows a REIT fund, Vanguard REIT index, VGSIX.
The orange line is a bond fund, Vanguard Total Bond Market Index Fund, VBMFX.
The green line is a general stock market fund, Vanguard Stock Market Index Fund, VTSMX.

Considering them overall, and taking into account return, and risk as measured by volatility and maximum drawdown, and how they would function in a portfolio, would you say the blue line, REITS, is

a) More like bonds, the orange line, or
b) More like stocks, the green line?

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Image
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dbr
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Re: Should REITs and BDCs be looked at more like bonds?

Post by dbr » Sat May 26, 2018 11:00 am

I think the error is in trying to think that things that pay dividends look like income which is [sic] bonds, when the actual decider is risk and return, especially risk.

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nisiprius
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Re: Should REITs and BDCs be looked at more like bonds?

Post by nisiprius » Sat May 26, 2018 11:06 am

alex_686 wrote:
Sat May 26, 2018 10:15 am
zengolf2011 wrote:
Sat May 26, 2018 10:11 am
REITs have the same level or return and volatility as the overall market. However, for a asset to reduce volatility it does not have to have low volatility. It can actually even have higher volatility. What it needs is a low correlation with the other asset classes in the portfolio.
In theory it is true that "for a asset to reduce volatility it does not have to have low volatility. It can actually even have higher volatility. What it needs is a low correlation with the other asset classes in the portfolio." In practice, in the real world such assets are hard to find.

Using PortfolioVisualizer's choices and time spans for "asset classes," Portfolio 1 (blue) is 60% "US Stock Market," 40% "Total US Bond Market." For Portfolio 2 (red line) I replaced the stock allocation with an equal split between total stock market (30%) and REITs (30%).

Did it reduce the volatility of the portfolio?

Source

Image

If we deliberately restrict our view to 1999 through 2003 inclusive, then, indeed, during this time period REITS made a spectacular improvement. I think a number of asset classes earned a reputation as effective diversifiers during this time period, but I think it was just "one brief shining moment."
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: Should REITs and BDCs be looked at more like bonds?

Post by staythecourse » Sat May 26, 2018 1:22 pm

nisiprius wrote:
Sat May 26, 2018 11:06 am
alex_686 wrote:
Sat May 26, 2018 10:15 am
zengolf2011 wrote:
Sat May 26, 2018 10:11 am
REITs have the same level or return and volatility as the overall market. However, for a asset to reduce volatility it does not have to have low volatility. It can actually even have higher volatility. What it needs is a low correlation with the other asset classes in the portfolio.
In theory it is true that "for a asset to reduce volatility it does not have to have low volatility. It can actually even have higher volatility. What it needs is a low correlation with the other asset classes in the portfolio." In practice, in the real world such assets are hard to find.
That's easy. Hide it under your mattress or put it in cash. The problem is NOT finding assets that have low correlation to stocks. The problem is exchanging low correlation for low expected returns. So, in theory that means instead of generating 10% returns with HIGH volatility you get 6% returns with smooth returns (low volatility). That is the problem (if you were to call it that) of adding lower expected return bonds to equities. They have lower correlation, but the expected returns are much lower as well. That means the investor is choosing lower expected returns for smoother returns. Again, life teaches us there are no free lunches.

That is what the great argument for CCF were in that seminal article. They presented the holy grail of HIGH volatility asset class with low to no correlation to equities. That is the HOLY GRAIL. In real life since 2006 when CCF became vogue they still have low correlation, but their returns have been low. So that means less volatility of the portfolio as a whole when mixed with equities, but in exchange for lower expected returns. That is why I have always advocated (not sure why no one else does) the best mix of CCF is NOT with equities, but a bond heavy portfolio. In that situation, both of their expected returns are much lower and similar and the low correlation would smooth out the returns even more. Also, since CCF are great for short term unexpected inflation they mix nicely with a portfolio of nominal bonds.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

zengolf2011
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Re: Should REITs and BDCs be looked at more like bonds?

Post by zengolf2011 » Sat May 26, 2018 2:35 pm

On their risk potential index, I believe Vanguard ranks their Total Bond Market Index fund a 2 (conservative to moderate risk) and their REIT a 4 (moderate to aggressive).

NYCwriter
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Re: Should REITs and BDCs be looked at more like bonds?

Post by NYCwriter » Sat May 26, 2018 8:20 pm

I've held the VG REIT fund for quite a while, since I originally set up my taxable/Roth as a Swenson lazy portfolio. I no longer believe in them as a necessary alt investment, but have always factored them as part of my equity allocation. If you want to compare to bonds, maybe very high yield corporate comes closest?

They offer exposure to real estate, but with the advantage of liquidity. I think this is what defines them as an alternative class. Perhaps similar to how GLD offers liquidity without the need to own physical gold.

I do think the main appeal has been the high payouts in a low interest rate environment, which made BDCs, high-div telecom, utility, and consumer equities attractive. Similarly, they suffer from both interest rate risk and sector risk. With cos like Realty or SPG... these are companies considered reliable, but they are not guaranteed.

US-backed bonds have interest rate risk, but what's the sector risk? The gov't would have to fail, maybe.

I use Personal Capital to check my allocation since I have different tax/deferred/Roth vehicles, and it's a bit annoying that PC considers REITs alternative assets instead of my equity allocation, and keeps telling me I don't have enough of them (REITs, gold) in my portfolio. I sometimes wish I'd closed my fund by now, but I don't like to make reactive decisions on my portfolio and it will likely pay out a lot more this year than the small capital loss I'm carrying. It's still on the chopping block as part of my 18-year march toward retirement simplification strategy.

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Re: Should REITs and BDCs be looked at more like bonds?

Post by asset_chaos » Sun May 27, 2018 3:35 pm

ChinchillaWhiplash wrote:
Sat May 26, 2018 9:10 am
Seems like these asset classes are more like bonds with their business structure and having to pay out at least 90% of profits back to shareholders as dividends. If not, they certainly should not be looked at quite the same as a standard common stock, should they?
I would say definitely wrong on the first statement and right on the second. Below is a factor analysis from portfolio visualizer for Vanguard's REIT fund, total bond fund, and total stock fund.

Code: Select all

Name	                               Ticker		Rm-Rf	TRM	CDT
Vanguard Real Estate Index Investor	VGSIX		0.91	0.73	0.56
Vanguard Total Bond Market Index Adm	VBTLX		0.00	0.21	0.17
Vanguard Total Stock Mkt Idx Adm	VTSAX		1.00	0.03	0.00
where Rm-Rf is sensitivity to the stock market, TRM is the term factor (think bond maturity), CDT is the credit quality factor, and I only display factors that are different from zero.

Are REITs like bonds? They have characteristics of longer term and lower quality bonds compared to the bond market, but they also behave strongly like stocks: they have a large market factor of 0.9 instead of the 0 that real bonds have. You can easily see the difference in the graph nisiprius posted above.

Are REITs the same as common stocks? Indeed they are not. Regular stocks are not sensitive to the term and credit factors, but REITs strongly are.

REITs are a hybrid security with characteristics of both stocks and bonds. They are not a bond substitute.
Regards, | | Guy

ChinchillaWhiplash
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Re: Should REITs and BDCs be looked at more like bonds?

Post by ChinchillaWhiplash » Sun May 27, 2018 3:44 pm

How do mREITs fit into the picture with their mortgage servicing rights and hedging strategies? How many of these companies are included in the REIT indexes?

alex_686
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Re: Should REITs and BDCs be looked at more like bonds?

Post by alex_686 » Sun May 27, 2018 4:03 pm

ChinchillaWhiplash wrote:
Sun May 27, 2018 3:44 pm
How do mREITs fit into the picture with their mortgage servicing rights and hedging strategies? How many of these companies are included in the REIT indexes?
Think banks. GICS has carved out a sector for REITs and a sub-sub-sector for financial REITs, which falls into the financial sector.

The act much like old time banks which worked the carry trade. Short term low interest loans to finance them, long term higher rate loans as assets. There is a low correlation between these 2 assets classes.

Some indexes and funds include them, others don't. You will need to read the fine print.

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Re: Should REITs and BDCs be looked at more like bonds?

Post by nisiprius » Sun May 27, 2018 4:14 pm

ChinchillaWhiplash wrote:
Sun May 27, 2018 3:44 pm
How do mREITs fit into the picture with their mortgage servicing rights and hedging strategies? How many of these companies are included in the REIT indexes?
Invest in them or don't invest in them, but calling stocks "bonds" is not going to do you or anybody else any good. It's just blurring the picture, it won't help you understand your investments.

And, frankly, it sounds like a seller's pitch. Did someone tell you to regard them as being "like bonds?"

So, let's try the same basic exercise as before, only this time let's use the iShares Mortgage Real Estate Capped ETF, REM:
The iShares Mortgage Real Estate ETF (the “Fund”) seeks to track the investment results of an index composed of U.S. real estate investment trusts (“REITs”) that hold U.S. residential and commercial mortgages.
Again, please, you tell me: in your personal opinion, in your judgement,
is the blue line (mREITs, REM)
more like the orange line (bonds, VBMFX)
or the green line (stocks, VTSMX)?

Source

Image

This is "all available data," and it appears as if REM was launched at an inopportune time. My point is "risk," not return, so perhaps it is worthwhile looking at a time period picked to exclude whatever horrible thing happened to mREITs in 2007-2009. That is, in the next chart, I have deliberately modified the time period in favor of mREITs.

Again, please you tell me: over the time period shown, did mREITs (blue) behave more like bonds (orange) or like stocks (VTSMX)?

Image
Last edited by nisiprius on Sun May 27, 2018 4:21 pm, edited 3 times in total.
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Agggm
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Re: Should REITs and BDCs be looked at more like bonds?

Post by Agggm » Sun May 27, 2018 4:18 pm

zengolf2011 wrote:
Sat May 26, 2018 10:11 am
Most portfolios rely on bonds to provide safety and reduce volatility. REITs and BDCs provide neither. I think that they are sensitive to interest rates (as are bonds), but are higher-risk, possibly higher-reward investments. They perhaps share some characteristics of high-yield bonds, but may not be well-suited for most portfolios.
Reits can reduce the volatility of a portfolio over a long period of time since the correlation of reits to broad stocks cycles from very low to very high.

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nisiprius
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Re: Should REITs and BDCs be looked at more like bonds?

Post by nisiprius » Sun May 27, 2018 4:25 pm

Agggm wrote:
Sun May 27, 2018 4:18 pm
zengolf2011 wrote:
Sat May 26, 2018 10:11 am
Most portfolios rely on bonds to provide safety and reduce volatility. REITs and BDCs provide neither. I think that they are sensitive to interest rates (as are bonds), but are higher-risk, possibly higher-reward investments. They perhaps share some characteristics of high-yield bonds, but may not be well-suited for most portfolios.
Reits can reduce the volatility of a portfolio over a long period of time since the correlation of reits to broad stocks cycles from very low to very high.
Perhaps they "can" reduce the volatility of a portfolio, but did they?

Please look at my posting above. During the entire time when the Vanguard REIT index fund has been available, a portfolio of 30% Total Stock Market, 30% REITs, and 40% Total Stock had slightly more volatility than a plain-jane 60% Total Stock/40% Total Bond portfolio, and a slightly lower Sharpe ratio. You can't say the REITs did significant harm, but there was no improvement from the inclusion of REITs.
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: Should REITs and BDCs be looked at more like bonds?

Post by vineviz » Sun May 27, 2018 8:51 pm

nisiprius wrote:
Sun May 27, 2018 4:25 pm
Agggm wrote:
Sun May 27, 2018 4:18 pm
Reits can reduce the volatility of a portfolio over a long period of time since the correlation of reits to broad stocks cycles from very low to very high.
Perhaps they "can" reduce the volatility of a portfolio, but did they?
Indeed, adding REITs to a stock portfolio has historically done a worse job of diversification than simply adding a mix of other assets.

For instance, adding a 50/50 mix of long term treasury bonds combined with either small or mid cap value stocks was decidedly superior: similar absolute returns, higher Sharpe ratios, higher diversification ratios, and lower drawdowns than adding REITs.

https://www.portfoliovisualizer.com/bac ... 5&REIT1=30
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Re: Should REITs and BDCs be looked at more like bonds?

Post by HEDGEFUNDIE » Sun May 27, 2018 10:17 pm

Following this topic with interest.

The standard etf for BDCs is (appropriately) BDCS. Would be curious to see the risk-adjusted return characteristics on this one relative to what has already been discussed above.

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Re: Should REITs and BDCs be looked at more like bonds?

Post by asset_chaos » Sun May 27, 2018 11:21 pm

HEDGEFUNDIE wrote:
Sun May 27, 2018 10:17 pm
The standard etf for BDCs is (appropriately) BDCS. Would be curious to see the risk-adjusted return characteristics on this one relative to what has already been discussed above.
As porfolio visualizer has data for BDCS, we can continue the factor regression in my post above.

Code: Select all

Name 	                                Ticker 	Rm-Rf 	SMB 	TRM 	CDT
UBS ETRACS Wells Fargo Busn Dev Co ETN 	BDCS 	0.50 	0.65    0.00 	0.71
where the additional factor SMB is exposure to company size. Like REITs, this business development company ETN is a hybrid security. Roughly it has behaved like it's a portfolio holding about half small cap stocks and half short term junk bonds. I don't quite fully understand what that means on its own terms, but it definitely means that BDCs are not a bond substitute.
Regards, | | Guy

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Re: Should REITs and BDCs be looked at more like bonds?

Post by ChinchillaWhiplash » Mon May 28, 2018 8:55 pm

Thanks for all the replies. Not really looking to replace bonds with something else, but was curious if these "asset classes" could complement them. Looks like both REITs & BDCs behave more like normal equities with the bonus of higher yields. Both are very interest rate sensitive which seems to make them more volatile. I think their way of raising new capital through secondary public offerings also plays into the volatility. Still with the higher overall returns makes it somewhat attractive to have in the portfolio. Seems to be a bit out of sync with overall market too, but not by much. Definitely doesn't come close to beating the S&P 500 for total return and probably never will. Do you see any reason not to include about 10% of equities in this sector (low cost index fund of course)?

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