Strategies For Uncertain Times: Global Real Estate

Overview: I buy mostly CEFs trading at a discount which can be held long-only or arbitraged by shorting various real estate indexes. The CEFs have unusual properties (pun intended) including high leverage and high current income from REIT dividends. This is also a contrarian investment on a turnaround in the real estate markets. Real estate, both in the US and internationally, falls into two main buckets: commercial and residential. Residential real estate investments are primarily made by investing in RMBS fixed income (residential mortgage backed securities) and are a very, very unusual investment given the dynamics of the US residential real estate market. Commercial real estate can be general purpose office buildings, medical facilities, shopping malls, etc. Commercial real estate companies can be purchased directly as many are listed and structured as REITs (real estate investment trusts), and there are also real estate service firms like CB Richard Ellis that are dependent on commercial real estate market trends. CMBS (commercial mortgage backed securities) are also an option on the debt-side, but the uncertainty regarding that particular sub-segment of the ABS (asset backed securities) market and I avoid it entirely given my inexperience with actual CMBS investing.

Global Real Estate

Overview: Roughly 0.3 beta vs. S&P. Contrarian play on turnaround in real estate. High dividends income. Probably best to hold in a tax advantaged account because of the high income from REIT holdings which gets taxed at ordinary tax rates (REIT dividends don’t qualify for low dividend tax rate).

• Open-end mutual funds: The open end funds are not as global as the CEFs
  • TAREX: Third Avenue Real Estate Value
    • 56% international
    • 1.1% annual fee, no load
    • 5 year annualized return of 1.5%
    • 30% std dev and 1.1 beta vs. MSCI on 3 year basis
    • Avg cap is medium although is across all caps
    • 17 positions
    • 30% annual turnover
    • About 20% Hong Kong
  • ARIIX: Alliance Bernstein Global Real Estate II
    • 64% international (more international/global than TAREX)
    • 5 year annualized return of 1.9%
    • 30% std dev and 1.1 beta vs. MSCI on 3 year basis
    • Avg cap is medium although is across all caps
    • 14% Hong Kong
    • 95 positions
    • About 60% annual turnover
• CEFs:
  • AWP: Alpine Global Premier Property
    • Estimated avg discount is 12% (only 2.5 years of history in unusual situation)
    • Current discount is 21%
    • Monthly distributions, does NOT have managed distributions
    • US is 33%, but beyond that it’s the most geographically diverse
    • Very liquid, very big fund
    • Entirely equities
    • 1.45% annual expense
    • 138 holdings
    • Does not use leverage, but can (no further discount, but have upside optionality)
    • Already cut distribution 8 months ago, more likely to get raised, not cut
    • Equity REITs have relatively stable balance sheets (debt to total capital)
    • Commercial MBS will face the most trouble, they don’t touch it.
  • DRP: DWS RREEF World Real Estate & Tactical Strategies
    • Estimated avg discount is 14% (only 2.5 years of history in unusual situation)
    • Current discount is 21%
    • Monthly distributions, does NOT have managed distributions
    • 80% equities, the rest is preferreds, debt, and covered calls
    • US is 27%, 15% Australia, 14% Hong Kong, 12% UK, then Japan
    • 1.38% annual expense
    • 119 holdings
    • $90m total NAV, much smaller than $633m for AWP
  • SLS: Riversource LaSalle International Real Estate
    • Estimated avg discount is 14% (only 2.5 years of history in unusual situation)
    • Current discount is 23%
    • Quarterly distributions, does NOT have managed distributions
    • US 16%, Australia 21%, Japan 14%, then UK, then France
    • 1.26% annual expense
    • Entirely equities
  • IGR: ING Clarion Global Real Estate
    • Monthly distributions and DOES have managed distributions
    • Current discount is 13.5%
    • Very liquid, largest of the CEF RE funds at $1.36bn
    • 1.28% annual fee
    • 53% US, 12% Australia
    • 74% equities, 25% preferreds
    • 5 year avg discount is 8.6%*** good reference for the younger RE CEFs
    • 71 holdings, extremely low turnover
• ETFs:
  • GRI: Cohen & Steers Global Realty Majors
  • RWX: SPDR Dow Jones International Real Estate
  • DRW: WisdomTree International Real Estate
  • WPS: iShares S&P Developed ex-U.S. Property

Other Notes:

• Have to get the portfolio holdings info from the fund mgmt sites themselves

Strategies For Uncertain Times: THE OVERVIEW

I believe that tremendous uncertainty supports the adoption of hedge fund replication strategies.

At the end of 2008 I felt very certain that, given the oversold levels of various equity markets around the world, a basket of China, India, and LatAm (Brazil) were extremely likely to experience very solid price appreciation. Multiples for their respective indexes were lower than they were in the US (which is rare) and I knew that emerging market economies will precede the US coming out of the trough of the macro cycle. Additionally, their macroeconomic situations were comparatively healthy versus the US. In retrospect, it was a no-brainer and a huge winner. I nearly bottom-ticked those equity markets and ended up doing extremely well on a percentage/relative basis as their TTM performance has been stellar.

This year I have the entirely opposite mindset: I have ZERO idea what will happen to equities over the next two years and I think anyone who says they do is selling a theory that they can’t realistically support as actually PROBABLE. Hence, I’ve put together a list of strategies/asset classes that, in aggregate, satisfy my desire to make money over the next year or two. Some ideas are targeted at generating current income, some ideas are targeted at capturing potential equity market appreciation, and some ideas are just uncorrelated strategies or asset classes that offer non-equity means of potentially increasing in value (income plus price appreciation).

Some people refer to compiling these strategies and/or adding non-equity  asset classes  as “hedge fund replication” whereas I just call it considering your alternatives (zing). I believe that, while unlikely to repeat the huge outperformance of my portfolio this over past 12 months, this strategy should produce sold tax-managed returns with favorable volatility over the next one to two years. This is really just a study I prepared for myself (AKA The Dan-Don’t-Be-Broke-Portfolio), but you might find some interesting info for yourself.

There is a considerable amount of disagreement about the definition of the term “hedge fund replication” but, to me at least, it means any combination of three things: 1) not being exclusively long equities (long only), 2) maintaining short exposure as a hedge against bearish moves in equities or the economy overall, and 3) looking at various asset classes and strategies that seek to generate uncorrelated or low-correlation returns with equities.

Clearly 2008 demonstrated that many “hedge funds” were not appropriately hedged, if at all. If the S&P was down 30%+ in 2008 and hedge fund XYZ was down roughly the same amount, then they did not come close to producing returns for their investors that were either 1) positive on an absolute basis (greater value at end-of-period than at beginning-of-period), or 2) positive on a relative basis (lost less value on a percentage basis than the S&P, which is admirable but still fails to increase investor wealth), and 3) most likely generated a return that was highly correlated with the performance of the S&P, which is not acceptable given that investors pay high fees to hedge funds in the expectation that they do NOT produce results similar to what the overall equity market does.

This list is not inherently “fully hedged” or “market neutral” but the list (when aggregated as a portfolio) has a correlation with the S&P of less than 1.0 and potentially has the ability to increase in value even if the S&P falls.  Obviously, my allocation to each of these strategies will vary greatly depending on changes in value, and I might not even currently employ any one of them at all.

Non equity asset classes:

-Commodities

-Debt (emerging market)

-Debt (floating or variable corporate)

-Muni bonds

-Closed end fund (CEFs) arbitrage

-Private equity and/or venture capital (PE and VC)

-Currencies

-Convertible bond arbitrage

Equity-based strategies:

-Merger arbitrage and special situations

-Closed end fund Fund-of-Funds (CEF FoF)

-Biotechnology

-Stock buyback funds

Covered call funds (buy-write strategy)

Real estate (US and/or international)

Long/short equity (partially hedged or market neutral equity)

Managed futures (this can mean several things)

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I have prepared my own investment guide that spans all of these strategies. You can download it by clicking here.

Strategies For Uncertain Times

I prepared it awhile back, so it may not reflect current market conditions, valuations, or discounts. It is based on my own financial situation, goals and objectives, risk profile, and tax considerations. My picks/selections are bolded, there may be two per strategy/asset class. In many cases I prefer closed-end mutual funds (CEFs) b/c they trade on an exchange like stocks, and frequently trade at discounts to their “net assets” per-share, which occasionally creates a built-in margin of safety. I will continue to hold a good portion of emerging market equities, which I trade in and out of depending on valuation on price changes. I hold HAO for China, GML for Latin America, RSX for Russia, and EPI for India. I just typed up my handwritten notes, so there are plenty of abbreviations, typos, and short-hand notes. The format isn’t meant to be anything more than acceptable, so just call me if you have a question about what something means or what I’m thinking.