A Diversified REIT ETF may Proxy Physical Real Estates in an Asset Allocation Model

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The Correlation Matrix (top graphic) shows the correlation between the S&P 500 and five publicly traded Real Estate Investment Trust (REIT) ETFs. While MORT is a mortgage REIT, the other four are diversified equity (Real Estate) REITs. 

The Correlation Matrix shows almost negligible correlations between the S&P 500 and the REITs. This lack of correlation entices investors to own REITs as a separate asset class in their asset allocation model, proxying a portfolio of diversified real estates (residential, commercial, and industrial) without physically owning and managing them. 

To maintain the tax advantage status, REITs have to pay out at least 90% of their income as a dividend. Since REITs are designed to yield higher dividends, they tend to complement the fixed income (asset) class in the asset allocation model.

Correlation coefficients ranging between + 0.10 and -0.10 are considered uncorrelated. VNQ is the only one that falls outside of that range, showing a slightly negative correlation. Save MORT, the other four equity REITs are moving in lockstep, considering their top holdings (accounting for at least 35% of the portfolio) are virtually alike (e.g., American Tower, Simon Property, Crown Castle, Prologis, Public Storage, Avalon Bay, Equinix, Equity Residential, Digital Realty, etc.).

Though Mortgage REITs tend to generate much higher yields than their equity (real estate) counterparts, they are inherently more volatile as they are more prone to interest rate fluctuations. MORT currently has a yield of 7.77% compared to 3% to 4% for the equity ones.

   

The weekly graph (bottom graphic) is more telling. While the S&P 500 moved from 2,400 to 2,800 (between 8/1/17 and 7/31/18), both REITs (IYR and VNQ) remained range-bound between $74 and $82. As a result, the diversified equity REITs have low beta (usually between 0.5 and 0.7). 

Again, a diversified equity REIT ETF could be an excellent way to own this asset class (a wide variety of real estates) without physically owning and managing them.

Disclaimer - The author is not advocating any of the ETFs/indices listed here. Consult your Registered Rep, RIA, or Financial Planner for an appropriate asset allocation model and the suitability of stocks and other holdings for your portfolio.

- Sid Som

homequant@gmail.com

Link to the Book

How did Dow Jones Industrial Average (DJIA) Fare in 2019?

** Intended for New Graduates **

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Jason is interviewing for Senior Research Analyst with a major brokerage house.

Interviewer
Question # 1: How would you interpret the 2019 DJIA trend?

Jason: Visually, it's a linear trend. It has been trending at 45 degree. 

Interviewer
Question # 2: When you say 'Visually,' do you mean there could be a better technical trend?

Jason: Yes, a polynomial trend would show better fit with significantly higher r-squared. Yet, I would stick to the linear trend as it would be easier to explain to the general clientele.  

Interviewer
Question # 3: What is the missing piece between these two graphs? Or, is there one?

Jason: Volatility. While the Weekly one depicts the market volatility, the Monthly one irons it out. 

Interviewer
Question # 4: Is there another way to depict the market volatility? If so, would that make the volatility case any stronger?

Jason: The Daily closing graph will show higher volatility but it won't make a better case than the Weekly one. As you know, a level of smoothing -- which the Weekly one incorporates -- is a better way to present volatility to the general clientele. 

Interviewer
Question # 5: What market event is common in these two graphs?

Jason: The precipitous market drop in May, bringing Dow under 25,000. Of course, by early July, Dow climbed to a new high, crossing the 27,000 mark. 

Interviewer
Question # 6: Do you think the May correction was driven by basic fundamentals of the market?

Jason: No. It was more news driven like trade, tariffs, etc. than pure market fundamentals. 

Interviewer
Question # 7: How did you come to the conclusion that it was news-driven rather than fundamentals-driven?

Jason: Had it been fundamentals driven, the correction would have lasted much longer. Instead, you can see the immediate V-shaped recovery leading to new market highs.

Interviewer
Question # 8: What is the difference between the 2-period and 3-period moving averages in the above graphs?

Jason: The 3-period in the Weekly graph points to 3-week moving average, whereas the 2-period in the Monthly refers to 2-month moving average.

Interviewer
Question # 9: Would you advise your clients to continue to pour in money in Dow in Q1-2020? 

Jason: Selectively. I will continue to recommend the Dow components with high dividend payouts. I will also urge them to keep some cash handy, just in case a correction occurs, leading to good buying opportunities.

-Sid Som, MBA, MIM
President, Homequant, Inc.
Homequant@Gmail.com

Link to the Book

Consider these Additional Factors while Choosing High Dividend Stocks - for Long Haul

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In choosing a set of high dividend stocks for the long haul, data savvy investors need to additionally consider, at a minimum, price-earnings ratio and volatility. Of course, equity research analysts would consider a slew of other factors including book, cash, reserve, growth, liquidity, debt, etc.  

A composite combining PE and Beta (or V-factor) is critical. The two composites - Beta-adj and Vfact-adj - have been used (the graphic above) to make the case. While the Beta-adj composite points to Verizon (VZ), P & G (PG), IBM (IBM Corp.), XOM (Exxon Mobil), GE and JNJ (J & J) as the best (< 50 as acceptable scale value) high dividend stocks, Vfact-adj picks PG, VZ, XOM, IBM and MRK (Merck). 

Despite high dividend yields, CVX (Chevron) and KO (Coca Cola) didn't make either cut due to high PEs. Likewise, BA (Boeing) didn't fare well either due to the high volatility.

Disclaimer - The author is not advocating any of the stocks listed here; instead, this is promoted as an alternative research in creating a statistically significant and more predictive volatility factor for individual stocks. Consult your Registered Rep, RIA or Financial Planner for an appropriate asset allocation model and the suitability of stocks and other holdings.  

-Sid Som, MBA, MIM
President, Homequant, Inc.

homequant@gmail.com

Link to the Book