Don't bet momentum on global REITs

Key takeaways

  • Despite the temptation to double down on investing in countries or regions that have performed strongly in recent periods, we think investors would do well to avoid overreacting, stay flexible, keep studying economic developments around the world, and be prepared to take advantage of changes in the broader investment outlook.
  • U.S. real estate investment trust (REIT) markets appear likely to remain competitive in the coming quarters, but it’s not too soon to view them through a slightly defensive lens.
  • Historical data show that when added to a portfolio of traditional stocks and bonds, global REITs can have a positive effect on returns while only marginally increasing volatility.

It’s human nature to believe past performance will repeat itself. It can be tempting to double down on investments that have performed strongly in recent periods. But doing so comes with risk, because upward momentum doesn’t last forever, and timing the next downturn is difficult to do. Real estate securities are not exempt from this reality.

On the eve of the global financial crisis in 2008, many professional investors believed that real estate markets outside the United States would continue their then-dominant stretch of outperformance of the previous five years. Consequently, heading into the final months of 2008, these investors increased their holdings of ex-U.S. REIT assets. They didn’t know it at the time, but they were doing so at their own peril. As is often the case with investing, they would have done better by being patient.

Past performance is no indication of ... do we have to say it?

Moving into 2009, REIT markets were unkind to those who assumed that ex-U.S. markets would continue outperforming. U.S. REITs took the lead, beginning a period of outperformance that would last until this year. In the wake of such a streak, we are now seeing renewed signs of demand for U.S.-only mandates. In our view, this reaction raises red flags. We think the better tactic is to avoid doubling down on U.S. REITs and invest in a global allocation instead. Two notes that help explain our thinking about the advantages of investing globally:

  • While we believe that U.S. REIT markets could very well remain competitive in the coming quarters, we think it makes sense to be aware of potential sources of pressure. For instance, the U.S. economy seems to be further along in the expansionary part of the economic cycle than many other countries, possibly inching closer to the next eventual contraction. REITs are economically sensitive, so any degradation in the U.S. economy will ultimately be felt in real estate fundamentals.

    What's more, the longer that interest rates stay at current levels, the greater the chance that the following sequence of events would play out: real estate prices will climb too high, which will provoke more supply, which in turn will dampen prices.
  • If the U.S. economic outlook weakens sooner than expected, opportunities in other countries could begin to look more attractive. With that in mind, we have already begun taking a more defensive position within the U.S. This doesn’t mean we are adjusting allocations reactively; an aggressive position in emerging markets, for instance, would not be timely, given the structural issues that those parts of the world are contending with.

    But we think investments in certain areas of Europe look attractive, in light of what we see as gradual but positive fundamental recoveries in Spain, Germany, France, and Ireland. We have also been adding exposure to Australia as we continue seeing more support for asset prices, partly due to an easing bias by the country’s central bank.

The case for a global REIT allocation

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Global REITs for the long term: Making a positive contribution to portfolio performance

Chart 1. Global REITs for the long term: Making a positive contribution to portfolio performance

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Global REITs for the long term: Making a positive contribution to portfolio performance

As illustrated by Blended Portfolio 2 in this scatterplot, adding a 20% allocation to global REITs offers investors competitive risk-adjusted returns relative to a portfolio composed solely of U.S. equities and U.S. bonds (as measured by the S&P 500® Index and the Bloomberg Barclays U.S. Aggregate Index, respectively).

January 1, 2000 through December 31, 2015

Blended Portfolio 1: 60% S&P 500 Index, 40% Bloomberg Barclays U.S. Aggregate Index

Blended Portfolio 2: 40% S&P 500 Index, 40% Bloomberg Barclays U.S. Aggregate Index, 20% FTSE EPRA/NAREIT Developed Index

Data: Barclays, FactSet, FTSE, and MSCI. Based on monthly total returns.

Why consider global REITs as part of a balanced investment portfolio in the first place? The answer is straightforward: Because an allocation to global REITs can provide exposure to nontraditional investments when added to a mix of traditional stocks and bonds. See the chart nearby for an example of how a global REIT allocation can enhance the risk-reward characteristics of a hypothetical portfolio.


The views expressed represent the Manager's assessment of the market environment as of September 2016, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting delawarefunds.com/literature or calling 800 362-7500. Investors should read the prospectuses and the summary prospectuses carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations. A REIT fund’s tax status as a regulated investment company could be jeopardized if it holds real estate directly, as a result of defaults, or receives rental income from real estate holdings.

International investments entail risks not ordinarily associated with US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

The S&P 500 Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the US stock market.

The Bloomberg Barclays US Aggregate Index is a broad composite that tracks the investment grade domestic bond market.

The FTSE EPRA/NAREIT Developed Index tracks the performance of listed real estate companies and real estate investment trusts (REITs) worldwide, based in US dollars.

Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.

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