Real estate securities strategies claimed nine of the top 10 spots in Morningstar Inc.’s domestic equity separate account/collective investment trust database for the year ended June 30, overthrowing large-cap value equity, which occupied six of the top 10 spots last quarter.
Rounding out the top 10 for the 12 months ended June 30 was a utilities strategy.
In the current low-interest-rate environment, real estate investment trusts and utilities are helped by their higher dividend payout ratios, said Andrew Daniels, manager research analyst, equity strategies, at Morningstar in Chicago.
For the three and 12 months ended June 30, U.S. real estate securities strategies in Morningstar’s universe returned a median 5.8% and 22.6%, respectively.
During the same periods, the overall domestic equity universe returned a median 2.2% and -1.9%, respectively; domestic growth, 1.8% and -3.5%; domestic value 2.6% and -0.3%; and domestic blend 2.3% and -4%. The Wilshire U.S. REIT index returned 4.7% for the quarter and 18.4% for the year, respectively, and the Russell 3000 index, 2.6% and 2.1%, by comparison.
The last time real estate dominated the one-year rankings was the first quarter of 2015, when it claimed five of the top 10 spots for the 12 months ended March 31.
Heitman LLC’s U.S. Focused strategy and U.S. Diversified strategy ranked first and fifth on the one-year list with gross returns of 27.1% and 25.2%, respectively.
The U.S. Focused portfolio invests in 20% to 25% of the Wilshire Real Estate Securities index and the U.S. Diversified, approximately 30%.
Over the past year, the strategies have benefited from an overweight to Physicians Realty Trust and Education Realty Trust Inc., and a collective underweight to the three large health-care REITs HCP Inc., Ventas Inc. and Welltower Inc., said Jerry Ehlinger, Chicago-based managing director and lead portfolio manager for public real estate securities.
Physicians Realty Trust, a health-care REIT and EdR, a student housing REIT, have benefitted from strong fundamentals and accretive investments, Mr. Ehlinger said. The collective underweight to HCP, Ventas Inc. and Welltower was based on valuations, concern over a high supply of new homes in senior housing and slow expected external growth, he said. HCP was also “dealing with a large lease that was not covering rent and needed to be restructured,” Mr. Ehlinger added.
Second on the one-year list was Levin Capital Strategies LP and its utilities yield strategy with a gross return of 27%, and the only holdover strategy from last quarter’s one-year list.
The portfolio is comprised of 10 to 15 utility companies whose returns are assigned by state regulators. The assigned returns are not contractual guarantees, but the companies “tend to earn close to those returns,” said Neil Stein, New York-based portfolio manager at Levin Capital. “In contrast to other sectors where return is a function of economic, market and competitive forces, utilities are insulated from those dynamics,” Mr. Stein said.
Top performers over the year included American Electric Power, which was up 37%, and Pinnacle West Capital Corp., which was up 48%. Additionally, Xcel Energy Inc., which was once viewed as a riskier utility company, was up 44%, Mr. Stein said.
“In the early 2000s, Xcel’s large non-regulated power business filed for bankruptcy. Subsequently, Xcel derisked its business by investing strictly in regulated activities. However, for many years the market still penalized Xcel’s valuation,” Mr. Stein said. “Xcel’s management has done a tremendous job of delivering stable earnings growth for several years, which has taken away the valuation discount they were getting and has awarded them a rising premium.”
Following Levin Capital was Cohen & Steers Inc.’s Realty Focus strategy with a gross return of 26.7%.
“Our job is to try to incorporate more macroeconomic data into a bottoms-up analysis” to create a portfolio of the 20 to 25 best ideas, said Laurel B. Durkay, New York City-based vice president and associate portfolio manager.
Ms. Durkay declined to name specific holdings, but said the investment team has been “focused on growth in technology over the past several years and the way it has manifested in increased real estate demand for data centers and West Coast offices. Landlords with exposure to those areas have been known to provide outsized cash flow growth and in my opinion, have been underappreciated by the broader REIT market.”
Ms. Durkay added that “the consumer retail landscape has been very challenged over the past several years, but landlords with exposure to high-quality (retail) centers have produced outsized cash flow growth and represented good value in the space.”
On the flip side, the portfolio team has “shied away” from suburban office centers and hotels, Ms. Durkay said.
“When thinking about the investment thesis for names, it’s really a function of three primary drivers of the real estate cycle — supply, demand and capital markets,” Ms. Durkay said. Hotels’ “drivers of demand tend to be more closely tied with macroeconomic indicators, which have been very mixed this year, thus creating significant volatility within the subsector returns,” she said.
Regarding the investment team’s avoidance of suburban offices, Ms. Durkay said, they are “generally associated with low barriers to entry coupled with obsolescence of existing stock and higher capex requirements.”
Behind Cohen & Steers was CenterSquare Investment Management Inc.’s REIT separate account with a gross return of 26.2%.
Themes and sectors that worked well for the strategy recently have been industrial, data centers and grocery-anchored shopping centers, said Todd Briddell, CEO, chief investment officer and strategy founder at the Plymouth Meeting, Pa.-based money manager.
Mr. Briddell declined to name specific holdings.
“Data usage in the cloud is growing at a terrifically fast rate,” creating the need for more data centers, and industrial real estate is getting a boost from Amazon and other online stores that need the space, Mr. Briddell said. Additionally, there is “natural demand” for grocery-anchored shopping centers with other service-oriented tenants such as a hair salon or dry cleaners “that’s unlikely to be cannibalized by Internet shopping,” he said.Total returns for the U.S. REIT market were basically flat in the year or 18 months leading up to the December 2015 Federal Reserve rate hike, “largely on the basis of expectations of rising interest rates,” Mr. Briddell said. In the last few months, however, REITs have gotten a boost with the Federal Reserve lowering its outlook for future increases and the market getting comfortable with rates remaining lower for longer, he added.
However, Mr. Briddell said he is beginning to see “pockets” in the U.S. commercial real estate sector where there is a supply of new development and potentially weakening demand. In Houston, for instance, there is new office development but weaker demand because of oil prices, he said.
Unlike the one-year returns, no one strategy type dominated the five-year return rankings, and only one real estate strategy — Chilton Capital Management LLC’s REIT strategy — made the top 10.
For the five years ended June 30, PIMCO’s StocksPLUS Long Duration strategy, a carryover from last quarter, occupied the No. 1 spot with a gross annualized return of 21.5%.
Behind Pacific Investment Management Co. LLC was Financial Trust Asset Management’s Health Value strategy with a gross annualized return of 20.5%.
The strategy’s investment approach has not deviated since its inception in May 2001, said Arno O. Mayer, founder, CEO, co-chief investment officer and portfolio manager at the Boca-Raton, Fla.-based money manager.
The portfolio team looks at valuation and momentum factors to build a portfolio of 50 health-care stocks.
All holdings are equally weighted and rebalanced to their 2% positions monthly.
While health care has been one of the stronger-performing sectors over the last five years, that has not been the case over the last six to eight months with politicians speaking out against high-priced pharmaceutical drugs, Mr. Mayer said.
The long-term drivers of the health-care industry, such as an aging demographic and medical innovation, are still in place, however, Mr. Mayer said.
Rounding out the top five strategies for the five years ended June 30 were Naylor & Co. Investments LLC’s Core Composite strategy with a gross annualized return 18.8%, followed by BNY Mellon Investment Management’s Dynamic U.S. Equity strategy at 17.1%; and BMO Global Asset Management’s Microcap Equity strategy at 16.8%. All three were holdover strategies from last quarter’s five year-ranking.
In the domestic collective investment trust universe, Fidelity Institutional Asset Management’s U.S. Real Estate Investment Trust led the one-year rankings with a net return of 24.7%, followed by Security Capital Research & Management Inc.’s Preferred Growth at 23.7%; AEW Capital Management LP’s U.S. Real Estate Securities Diversified Trust, 23.2%; American Century Investments’ U.S. Real Estate Securities Trust, 23.1%; and State Street Global Advisors’ REIT Index, 22.7%.
The median return for domestic collective investment trusts for the 12 months ended June 30 was -0.15%.