Energy strategies capture top equity slots, but real estate equity, REITs strong

NEW YORK — Strong equity returns were found in separate account energy strategies and real estate equity for the year ended June 30, according to Morningstar Inc.'s manager performance database.

The top two best-performing separate account domestic equity strategies for the year in the Morningstar database invested in shares of energy companies. Wellington Management Co., Boston, topped the list with a 54.5% return for its energy strategy, and the Energy-Publicly Traded Equities strategy managed by The Mitchell Group Inc., Houston, returned 44.5%.

In addition, six of the top 10 separate account winners for the year invested in either real estate investment trusts or stocks of real estate companies. The Real Estate Value Equity strategy, managed by Third Avenue Management LLC, New York, returned 41.7% for the year; Wellington's Real Estate Securities strategy returned 40.9%; the U.S. Real Estate strategy from Morgan Stanley Investment Management, New York, returned 40.5%. The Realty Focus and Realty Total Return strategies, both managed by Cohen & Steers Capital Management Inc., New York, returned 39.2% each, while the REITs and REOCs strategy managed by KRA Capital Management Inc., Fairfax, Va., returned 38.6%.

Those returns handily beat the Standard & Poor's 500 index, which returned 6.3% for the year, and the Russell 3000 index, with 8.1%. The Dow Jones Energy index returned of 40.1% for the year, and the NAREIT Composite Index returned 30.1%.

Rodney B. Mitchell, president and chief investment officer of the Mitchell Group, said increasing commodities prices are helping to drive performance. "It's the same story we've been seeing for a while now," he said. "Performance is the result of investor response to increases in oil exploration, production, increasing oil demand and much higher commodities prices. The cost of raw materials is going up in a tight world oil market. Investors have awoken to the dramatic change in the supply and demand of oil and natural gas."

The Mitchell Group is a fundamental shop that has about $700 million in separate accounts managing energy investments.

For the top real estate equity strategies, a growing economy, low interest rates and fundamental stock selection primarily drove performance.

"Occupancy levels in office buildings and shopping centers are going up, and so are rents. We're in a strong economy, and interest rates are low," said Michael Winer, a portfolio manager at Third Avenue Management, which manages about $100 million in separate accounts in the Value Equity strategy.

Mr. Winer emphasized that stock selection was the key to performance because evaluating the stock of a real estate company is difficult since its book value is based on property, which has to be valued. "We're focused on net asset value," he said. "We're always trying to buy a stock at a discount to its underlying value, but the screens are not that easy in real estate — book value tends to be meaningless."

Mr. Winer said one of the strong performers for the strategy over the past year was Forest City Enterprises Inc., a residential and commercial building developer.

Ted Bigman, managing director and portfolio manager at Morgan Stanley, said performance was strong across all sectors. "We are a good, old-fashioned bottom-up stock picker. We have created favorable outperformance in each sector — apartments, retail, offices and hotels, so it's actually been a great period for us. Companies that own major urban hotels have done especially well, since there's no negative new supply in that space. For example, Starwood (Hotels & Resorts Worldwide Inc.) did very well for us."

Mr. Bigman also noted the relatively low volatility of the strategy over the past year. For the year ended June 30, the standard deviation of the strategy was 13.3%, meaning that 68% of that time the returns swung 13.3 percentage points from the mean return. Morgan Stanley manages about $1 billion in the strategy.

Joseph M. Harvey, president of Cohen & Steers, said: "We think we're at a great point in the economy. Economic growth has been accelerating, and the fundamental characteristics of the companies in our portfolio are improving dramatically."

Mr. Harvey attributed much of the firm's success to a decision made last year to focus more heavily on real estate companies sensitive to the economy. "We saw increasing occupancy and rental rates, so that made us focus on properties that were sensitive to the economy, such as the office and hotel sectors and the apartment sector," said Mr. Harvey. "The first thing that differentiates our performance is that we decided that real estate fundamentals were going to improve more then people expected, and we acted on that."

The Realty Focus strategy is a concentrated version of the Realty Total Return strategy, said Mr. Harvey. The firm manages about $2 billion in the Total Return strategy and about $700 million in the Focus strategy.

Mr. Harvey also attributed performance to the firm's proprietary valuation methods. While he would not give details about it, he did point to holdings such as Brookfield Properties Corp., Boston Properties Inc. and Vornado Realty Trust as strong performers.

The five top separate account performers for the quarter were all real estate funds. The Cohen & Steers Realty Total Return fund returned 15.4% and the REIT strategy of Neuberger Berman Inc., New York, returned 14.9%. In third was Cohen & Steers Realty Focus fund with 14.8%, followed by the REITs and REOCs fund of KRA, with 14.8%, and real estate strategy fund of Morgan Stanley, with 14.6%. For the same period, the S&P 500 returned 1.37% and the Russell 3000 returned 2.2%, while the NAREIT index returned 13.5%.

Real estate and energy funds were also the best performers among commingled funds for the year. Wellington had the two best performing commingled funds for the year ended June 30: its Energy Tax-Exempt Composite fund returned 54.4% and its Real Estate Securities fund returned 40.9%. General Motors Asset Management, New York, had the third best performing commingled strategy — its Promark Real Estate Securities fund returned 36.1%; Dimension Fund Advisors, Los Angeles, was No. 4 with its Real Estate fund, which returned 33.7%. Grantham Mayo Van Otterloo LLC's GMO REIT fund returned 32.8% for fifth place.

For the quarter among commingled funds, the best performer was DFA's Real Estate fund, with 14.8%. The GMO REIT fund was second with 14.5%, and the GM Promark fund was third with 14%. Wellington's Real Estate Securities fund was fourth with 13.9%, and the REIT fund of Delaware Investments, Philadelphia, was fifth with 12.6%.