Real estate securities strategies dominated in 2014, claiming eight of the top 10 spots in Morningstar Inc.'s domestic equity separate account/collective investment trust database.
“The last time real estate appeared in the top one-year rankings was the second quarter of 2012, and then it was only two strategies,” said Nicholas Sundberg, data analyst, separate accounts at Morningstar in Chicago. “Having eight in the top 10 is unprecedented.”
Though real estate dominated the rankings, two equity funds took the top spots for the year. Absent from the list were master limited partnerships, which had occupied nine of the top 10 spots for the year ended Sept. 30. MLPs returned a median -8.73% in the fourth quarter, well below the median quarterly returns of U.S. real estate and overall domestic equity strategies, which were 14.42% and 5.31%, respectively.
“It was a complete turnover” from last quarter, Mr. Sundberg said, adding there was only one carry-over from the Sept. 30 top 10 rank: the StocksPLUS Long-Duration strategy of Pacific Investment Management Co.
The median return of domestic equity strategies in the Morningstar universe was 10.1% for the 12 months ended Dec. 31. The Russell 3000 index returned 12.56% for the period.
The top return for the year ended Dec. 31 was for Mazama Capital Management Inc.'s emerging small-cap growth strategy, with a gross return of 40.14%.
Ron A. Sauer, founder, CEO and chief investment officer of Portland, Ore.-based Mazama, said the portfolio team uses bottom-up analysis to select “the best growth companies in the market of $300 million to $1.3 billion.”
About 80% of holdings are drug, technology, consumer and financial services companies; industrials and materials make up the remaining 20%.
Among the portfolio's top producers were Diplomat Pharmacy Inc., Bluebird Bio Inc., Achaogen Inc., Esperion Therapeutics Inc., Calithera Biosciences, Hawaiian Airlines Inc. and specialty retailer Zumiez Inc.
“Zumiez had a huge year. They're doing exceptionally well in selling their goods in the teenage and young adult market, and they're doing a great job on social networking,” Mr. Sauer said.
To gain insight on which brands are gaining strength and which are not, the portfolio team will attend industry events, Mr. Sauer said. “We think we're really good at (figuring out what customers want to buy) because that's where we focus,” he said.
PIMCO's StocksPLUS Long-Duration was second in the year ranking, with a gross return of 34.45%. PIMCO's StocksPLUS strategy also ranked fifth on the five-year list, with an annualized gross return of 26.52%. The strategy combines S&P 500 derivatives with a portfolio of long-duration bonds. James Moore, managing director in Pacific Investment Management Co.'s Newport Beach, Calif. office, said the strategy is popular among pension plan sponsors who want to hedge their liabilities and retain their equity exposure.
PIMCO strategy was the only one to appear in both the one- and five-year rankings.
Third on the one-year ranking was Chilton Capital Management LLC's real estate investment trust strategy, with a gross return of 33.8%.
Matt Werner, an analyst and REIT portfolio manager at Houston-based Chilton, said the team's property type selection over the past year was “OK.”
“We're overweight apartments, which was the No. 1 performer” in 2014, Mr. Werner said. However, health-care properties, another top performer, were absent from Chilton's portfolio, he said. While that absence “did not help” the portfolio last year, Mr. Werner said he is still willing to overlook this property type because of its high sensitivity to interest rates among other reasons.
Like health-care properties, triple-net REITs also are absent from the portfolio, Mr. Werner said. Triple-net REITs are “companies that own (mostly) freestanding retail properties that are leased on a triple-net, long-term basis to its tenants, (meaning) tenants pay the real estate taxes, insurance and maintenance costs,” Mr. Werner explained.
He said he avoids these property types because of their higher payout ratios, sensitivity to interest rates and slow growth tendencies.
Rounding out the top five strategies for the year were Principal Real Estate Investors LLC's Principal Global Investors real estate equity securities strategy and Adelante Capital Management LLC's total return strategy with gross returns of 33.53% and 33.49%, respectively.
Principal's strategy invests in publicly traded real estate companies and real estate operating companies. Kelly Rush, Des Moines, Iowa-based CIO of global real estate securities at Principal Real Estate Investors, acknowledged as whole, real estate sector funds, not just Principal's, outperformed most general equity and other sector funds in 2014.
A combination of low interest rates and positive economic improvement in the U.S. made 2014 a “Goldilocks” year for real estate stocks, he said.
However, what put Principal ahead of some of its peers was its emphasis on economically sensitive real estate companies including hotel owners/operators and avoidance of American Realty Capital Properties, a real estate investment trust that returned -23.2% in the calendar year and faced litigation over alleged accounting irregularities, Mr. Rush said. An ARCP spokesman did not return a telephone call seeking comment by press time.
The five-year return rankings, while not a “complete turnover,” still went through a “shakeup,” Mr. Sundberg said. The median return for the five years was 15.8% and the Russell 3000 returned 15.63%. (All returns for periods of more than one year are compound annualized.)
In the collective investment trust universe, the J.P. Morgan Chase Bank U.S. real estate securities fund claimed the top spot with a one-year net return of 32.11%. State Street Global Advisors' REIT index strategy came in second, returning a net 31.85%. Also in the top five were Wilmington Trust Fiduciary Services Co.'s total return REIT fund, 31.51%; FMT/T. Rowe Price health sciences, 31.47%; and FMT/Nuveen real estate securities fund, with 30.83%.
The median return for collective investment trusts for the year ended Dec. 31 was 9.82%.
All of the data for Pensions & Investments' quarterly top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. For information on the database, please contact email@example.com or call 312-384-4087. n
This article originally appeared in the February 23, 2015 print issue as, "REITs take spotlight in "complete turnover' from previous quarter".