Key Debut For Real Estate Is A Big Opportunity For ETF Investors

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Brick by brick, REITs continue to solidify their place within investors' ETF strategies.

The industry is relatively young in terms of stock market history. The first real estate investment trusts (REITs) launched in 1960. Continental Mortgage Investors became the first REIT to be listed on the New York Stock Exchange in 1965.

Now another seminal moment nears.

In September, real estate gets promoted to a standalone sector by index providers S&P Dow Jones Indices and MSCI. The change is described as reflecting "the position of real estate as a distinct asset class and a foundational building block of a modern portfolio, rather than an alternative."

Real estate will join 10 existing sectors.

The move does more than raise the profile of REITs. It will significantly change the way that investors conduct sector ETF investing , says Todd Rosenbluth, director of fund research for S&P Global Market Intelligence.

For starters, many mutual fund managers benchmarked to the S&P 500 may have to increase their real estate stake. Plus, it is likely to firm real estate's place among the income-oriented and more defensive sectors that investors have flocked to this year.

"This creates an opportunity for REITs to do well, as investors and fund managers become more cognizant of their exposures," said Rosenbluth.

Giving Real Estate Its Due

Real estate has a 3.8% share of the S&P Composite 1500 -- more than the 3.3% weighting for materials, 2.5% for telecommunications and 3.7% for utilities, according to S&P Dow Jones Indices.

However, it is currently lumped within the financial sector, where REITs get dwarfed by big commercial banks, insurers and other financial service firms.

The portfolios of most U.S. investors are under-allocated to this asset class, according to investment management firm Gerstein Fisher.

"Our research has shown that an allocation to the asset class can substantially improve a portfolio's risk-adjusted return," said Gregg Fisher, the firm's chief investment officer.

REIT companies also tend to be less volatile than the overall financial sector, and that's luring investors in a herky-jerky stock market.

Vanguard REIT ( VNQ ), the largest exchange traded fund in its segment, has jumped 7.4% year to date through May 5. It made a 52-week high of 84.90 Friday as investors discounted the odds of a near-term rate hike following a glum jobs report.

Over the first four months of 2016, VNQ saw $2.14 billion in net inflow, more than any other equity sector ETF. Assets have grown to $31.49 billion. It yields 4.3%.

By comparison, Financial Select Sector SPDR ( XLF ) has given up 2.8% so far in 2016, and assets have shrunk to $16.27 billion. The real estate sector has a 15% weighting within XLF.

Flavors Of REITs

While offering exposure to the real estate sector, VNQ skews significantly towards midcap stocks, Rosenbluth said.

"It's not a perfect bolt-on product" for an S&P 500 investor who wants to overweight the real estate sector, he said. He finds a new ETF worthy of attention for a more tactical approach to sector investing.

Real Estate Select Sector SPDR ( XLRE ) invests in S&P 500 companies. Its top holding out of 27 is mall operator Simon Property Group ( SPG ).

XLRE joined the Select Sector SPDR ETF suite -- popular with tactical sector-based investors -- in 2015, ahead of the planned index changes. XLRE is thinly traded and has a meager $11.3 million in assets, but that could change with the elevation of real estate as a sector.

Fidelity MSCI Real Estate ( FREL ), benchmarked to an MSCI index, also launched in 2015. Like VNQ, it has a midcap tilt. However, these two ETFs have significant differences in holdings and industry exposure.

VNQ sold off in 2015, when interest rates were projected to rise. Dividend-paying REITs struggle to compete with other yield-bearing investments in a rising-rate environment.

Property REITs rank No. 19 out of 197 industry groups tracked by IBD. They were No. 53 a week ago.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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