For investors who bought real estate funds over the past few years, their year-end statement has provided a jolt, and created a need for self-evaluation.
The problem is that most people react to having their nerves frazzled without the personal exam, which can be a recipe for disaster.
In the entire equity universe, real estate had the longest string of positive performance, boasting gains for seven straight years leading up to 2007. Those profits weren’t wiped out by a year in which the average real estate fund lost just under 14 percent, according to Morningstar Inc., of which nearly 12 points came in the fourth quarter alone. By the time year-end statements started hitting mailboxes, however, REIT funds had dropped another nine points during the first two weeks of 2008.
Studies show that investors head for the door when a drop-off passes the 25 percent mark, and plenty of real estate funds now are there.
The knee-jerk reaction is why $7.1 billion flowed from real estate funds in 2007, according to AMG Data Services, marking the first year of net outflows for the category in eight years.
The outflows may have been a mistake however, not because of any great expectation for a REIT rebound this year, but because they may have damaged the investor’s asset allocation. This is where the self-assessment comes into play.
Many investors in REIT funds bought in well after the winning streak started. In 1999, the market was hot and tech and Internet funds were the rage. Real estate funds — a good diversifier for a portfolio because they don’t move in lock-step with the traditional markets — were shunned because their returns were ugly compared with the high-fliers.
It wasn’t until the bear market was well underway — in 2002 and 2003, after real estate funds had already gained more than 12 percent annually while the broad stock market was suffering losses of that same size — that a lot of investors took notice, and threw their money into real estate funds.
Frequently, investors justified the decision by saying they wanted REIT funds as a diversifier, and not just because they were hot. The market is now testing that thinking, and showing many to be liars.
“If you bought real estate for asset-allocation purposes, you might have taken some of your profits off the table during the big years, and you’re wondering if you need to buy more now to stay true to your allocation,” says Tom Roseen, senior research analyst at Lipper Inc. “If you said you wanted this to diversify your portfolio, but now you want to get out of it, then you’re chasing performance, plain and simple.”
Worse yet, Roseen notes that fund flows would indicate that investors who are pulling money from REIT funds may be making the same fundamental mistake again, putting the proceeds from their sales into international and emerging-markets funds, which are now several years into a strong bull run.
“They’re saying, ‘I don’t have enough international,’ but what they mean is ‘International funds have done really well lately, so I need to put more money there,’ ” says Roseen. “And they will keep that allocation until something bad happens to those funds. We’ve seen this before — the obvious example is technology funds right before the bear market in 2000.”
That being the case, investors need to ask themselves how well they have done in their performance-surfing. An investor who bought the average REIT fund five years ago still has annualized gains of about 16 percent to show for it.
Someone who really is concerned about asset allocation will make sure their real estate holdings are “on plan,” at or near the levels prescribed for the portfolio. They won’t go running into international markets beyond the level of their plan either.
