We’re always studying the global markets landscape and researching potential asset classes for inclusion in our portfolios. For some time, we’ve been analyzing international real estate as it relates to our allocations. We think this asset class makes sense and will benefit a large portion of our investment portfolios.
Desirable Investment Characteristics
When analyzing any asset class, we look not only at how it has performed as a stand-alone investment, but more importantly how it affects the risk/return profile of our globally diverse portfolios. International real estate meets the parameters we’re looking for, both in terms of returns and correlation to the other asset classes.
We consider hard assets like real estate to be part of the “growth engine” of the portfolio. International real estate exhibits acceptably low correlations to our US equity, US real estate, and fixed income positions while delivering equity-like returns over the long-term. In other words, it behaves differently enough from our other investments that it improves our portfolios’ diversification.
Rather than take from the equity side of the portfolio, we’ve decided to exit our commodities position to make room for international real estate. I don’t think it’s any secret that commodities have not been very fun to invest in over the last several years. Even though our fund returned 19.25% in 2016, the long-term picture has been less attractive.
The oil and gas sector has been the hardest hit. In July of 2014, Crude was trading well above $100/barrel and by January of 2016 it had dropped below $30. And as of today, we’re still 50% off the highs at around $49/barrel.
The price of oil, and commodities in general, will recover eventually. But the question we had to ask was whether we could improve our expected return outlook and risk profile, while reducing our exposure to the prolonged downturns commodities are susceptible to. I say “reducing” because we still have plenty of exposure to the commodities sectors within our allocations. The S&P 500 alone has over 10% allocated to energy and materials companies, including oil & gas, mining companies, etc.
Regardless of what the commodities asset class does in the short-term, we are confident that the move to international real estate will benefit our clients over the long-term.
The New Fund
The fund we’ve selected for exposure to international real estate is the DFA International Real Estate Securities Portfolio. As always, the DFA lineup of funds meets our criteria of very low internal expenses and tax efficiency.
The fund is also unique in this category in that its selection of securities is purer REIT (real estate investment trust) than most of its peers. One issue we’ve seen with many of the funds in this category is that they contain many securities that are not REITs, but rather stocks of “real estate related” companies like property developers, mortgage REITs, property managers, etc. This is not the real estate exposure we are looking for.
The DFA International Real Estate Securities Portfolio offered us the best exposure to the international REIT markets.
These REITs are diverse and include:
- Office Buildings
The fund is broadly diversified across 21 countries (developed and emerging markets) and includes over 273 securities.
While this change will impact a large percentage of our clients, it will not affect all of you. Rest assured that we are implementing these changes only where it will be most beneficial.
In most portfolios, we have embedded losses in the commodities fund, so making this move will enable us to harvest those losses in taxable accounts.
We anticipate the changes to the portfolios to occur within the next few weeks. As always, please contact us with any questions.