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Summary These ETFs offer respectable dividend yields by investing in REITs. I see VNQ as the top ETF in the batch, but if either were to beat VNQ over the long term I think IYR has a better chance of doing. Due to similarity of holdings between VNQ and FRI, it would be difficult for FRI’s underlying assets to outperform VNQ’s assets by enough to cover the expense ratio difference. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of a few domestic equity REITs ETFs that investors may be contemplating. Ticker Name Index IYR iShares U.S. Real Estate ETF Dow Jones U.S. Real Estate Index VNQ Vanguard REIT Index ETF MSCI US REIT Index FRI First Trust S&P REIT Index ETF S&P United States REIT Index Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. While IYR and VNQ are both yielding a little over 3.65%, the yield on FRI appears substantially lower. Since the yield was so weak I decided to look up the dividend history on Yahoo Finance and manually calculate it. Occasionally this results in a different value than the reported trailing yield. It isn’t common, but I wanted to double check some REITs ETFs will usually have higher dividend yields. There was no mistake that I could find. Expense Ratios The expense ratios run from .12% to .50%: VNQ is one of the cheapest REIT ETFs available. That is the reason I started building my own portfolio’s REIT allocation by buying up shares of VNQ. The combination of a very high yield and a low expense ratio made VNQ a natural choice for my portfolio. Strategy Earlier in the article I referenced which index each ETF would cover, but that doesn’t tell investors a great deal about how the individual allocations are created. Normally I would focus on comparing factors like the sector allocations of each ETF, but that wouldn’t make any sense when each ETF will simply be listed as being 100% invested in real estate. Fact Sheets To learn more about the ETFs, I pulled up the fact sheets for each: IYR’s Strategy Ironically, IYR does not explain their strategy in either the fact sheet or the general page on the ETF . I loaded up the prospectus on the ETF and finally found some answers. The fund managers use “a passive or indexing approach to try to achieve the Fund’s investment objective.” It is helpful to know that the fund is being passively managed, but it makes me wonder about the expense ratio. When the ratios are over .40% I usually expect to see some form of active management either in the portfolio or some rebalancing to follow an index that is changing significantly. The first response not being able to find the information I wanted in any of the three sources might be to look up the Dow Jones U.S. Real Estate Index, so I did that. It turns out that the Dow Jones Real Estate Indices do not include a single index with that precise name. Instead, they include several indexes with similar names. (click to enlarge) Without knowing precisely which of these indexes is being tracked, I don’t see a solid method to enhance the research. VNQ’s Strategy VNQ uses a passively managed, full-replication strategy and their index covers two-thirds of the REIT market. The fund’s management seeks to minimize their net tracking error by having a very low expense ratio. For investors that are not familiar with the net tracking error, it refers to the difference between the results of the ETF and the results of the index. A REIT is only eligible for inclusion in the index if it has a market capitalization of at least $100 million. RFI’s Strategy While the fact sheet does not discuss the strategy of the fund directly, they do discuss the index which gives us some insight. The index is maintained in a manner that includes implementation of daily corporate actions, quarterly updates of significant events, and the portfolio is reconstituted on an annual basis in September. The index appears to be passively managed as over each period the fund is lagging the index by a hair over the expense ratio. (click to enlarge) This is about how a passively managed fund should look when investors compare the NAV performance of the fund with the underlying index. An actively managed fund would miss by more significant amounts which could be outperforming the index or trailing it. Holding Similarity Since I’m seeing passively managed ETFs with materially different expense ratios, I wanted to determine how reasonable it would be for a substantial difference in performance. I checked the holdings of each ETF. The top holding across all 3 is Simon Property Group (NYSE: SPG ). It ranged from 7% to 8.35% of the holdings depending on which ETF I was looking at. VNQ and F had precisely the same top four holdings in the same order, though the percentage allocations varied slightly. Number two is Public Storage (NYSE: PSA ). Number three is Equity Residential (NYSE: EQR ). Number four is AvalonBay Communities (NYSE: AVB ). When the holdings are similar and the strategy is passive it is difficult to find any reason to expect the underlying portfolios to have materially different returns. IYR on the other hand did offer some different allocations. The second allocation there is American Tower Corp. (NYSE: AMT ) which is a REIT that operates cell phone towers. They are working in an oligopoly as there are only a few major cell phone tower REITs and the leasing structure on their facilities results in enormous economies of scale when they are able to increase the number of customers for each location. AMT is not in the top 10 holdings for either of the other REIT ETFs. Conclusion I tend to favor very passive management which is the trend for each of these ETFs. Without a compelling reason to pick either of the ETFs with a higher expense ratio, I see VNQ as the strongest REIT ETF in this batch. If IYR or FRI were to outperform VNQ over the longer term, I would expect it to be IYR because there appears to be a larger difference in the selection of securities which should reduce the correlation in the long run returns of the ETFs. Scalper1 News
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