With bond yields stuck on low, income-seeking investors are shifting to a different corner of the market: stocks of real-estate investment trusts.
Real-estate-focused mutual funds that are big buyers of REITs took in about $11 billion in 2019 and an additional $1 billion in the first three weeks of January, according to EPFR Global. Some funds that don’t specialize in real estate are also bulking up on REIT stocks to offset the falling yields of bonds they buy.
“We have a maximum overweight to REITs,” said MFS Investment Management strategist Rob Almeida, who runs a $4 billion mutual fund that aims to deliver steady income by investing about 60% in bonds and 40% in equities. Approximately one-quarter of the fund is in REIT stocks, meaning that more than half of the stocks it owns are REITs.
Sometimes called “bond proxies,” REITs buy up properties and pass on the bulk of profits to shareholders, delivering average dividend yields of about 3% to 4%, in addition to any profits from changes in their stock prices, according to MFS fund manager Rick Gable. Low interest rates tend to boost the companies by increasing the value of the properties they own and by stoking appetite for their shares from fixed-income investors who are getting paid less for owning bonds.
The strategy has gotten an extra lift this year as concerns that the coronavirus could slow global growth have turned investors cautious and increased demand for Treasury bonds, pushing rates even lower.
The 10-year Treasury yield fell to a three-month low of 1.6% and REITs have returned about 2.24% through January 27, compared with 0.49% for the S&P 500 (.SPX) and 1.57% for a widely tracked Bloomberg Barclays bond index, according to FactSet.
An S&P index of REIT stocks returned 24% in 2019, when the yield of the 10-year Treasury slid to around 1.9% from about 2.55% at the start of the year. The S&P 500 returned 31% last year, and the Bloomberg Barclays bond index returned 8.7%.
“There are a lot of investors who are looking for income in the equity market,” said Matt Jiannino, head of quantitative equity product management at Vanguard Group. “REITs tend to be very fixed income-like.”
A $4 billion low-volatility stock fund that Vanguard runs is about 16% invested in REITs, roughly three times the average allocation by comparable funds, according to data from Morningstar Inc.
Big bets on REITs could backfire if interest rates rise, but Mr. Almeida said that isn’t likely given muted inflation in most developed economies. There is greater risk in below-investment-grade bonds, he said, where yields have fallen to near record lows and investors are no longer being compensated for the possibility borrowers will default.
The expansion of REITs into markets ranging from timberlands, mobile homes, data centers and cellphone towers has given fund managers more options to differentiate themselves.
Kevin Preloger has invested about 15% of the $3.3 billion midcap stock fund he co-manages at Janus Henderson Group PLC in REITs, in line with the index he tracks. The fund returned about 30% in 2019, compared with the index’s 27%, in part because REITs it owns—including mobile and manufactured housing community owner Equity Lifestyle Properties Inc. (ELS)—returned almost 34% last year, he said.
“We’ve had a material weighting to REITs because of low interest rates and the REIT trade seems to be good until canceled,” Mr. Preloger said. Still, some of the fund is invested in REITs like cold-storage facilities for frozen foods, which are less likely to lag if interest rates rise than stocks tied to the housing sector like timber and apartment properties, he said.
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