Morningstar Advisor - December/January 2010 - 16

Investment Briefs REITs Look Good over the Long Term REITs struggled mightily in 2007 and 2008, returning negative 15.7% and negative 37.7%, respectively, after racking up double-digit percentage returns in seven out of the eight years between 2000 and 2006 (equating to a compound annual return of 22.3%). REITs have bounced back in 2009 thus far, producing an annualized return of 23.3% through September. Morningstar research and communications manager Jim Licato analyzed a longer (1972–2008) time period, and he found that REITs have generated an attractive compound annual return of 11.2%, placing them between large stocks (9.5%) and small stocks (12.5%). Breaking down the total return, the income generated from REITs has been relatively stable and consistent, while the price return has fluctuated widely from year to year. With clients who are hesitant to invest in REITs because of the most recent real estate crisis, it may be helpful to show them what they would have experienced if they held REITs over long time periods. Consequently, the volatility of this alternative asset class should become much more palatable for them. The chart below illustrates the realized losses in REITs for one-, five-, and 15-year periods. Of the 37 one-year periods from 1972 to 2008, eight periods resulted in a loss (22% of the years examined). When increasing the holding period to five years, however, none of the 33 overlapping five-year periods ended with a loss. Similarly, not one of the 23 overlapping 15-year periods produced a negative return. These results go back to the income potential of REITs, which are required to distribute at least 90% of their taxable income to shareholders on an annual basis. During a year in which REITs may be struggling from a price-appreciation perspective, it always has the income component to fall back on. On the flip side, when REITs are prospering from a price-return perspective, the income return further enhances the asset class’ total return. The real estate bubble and burst may have your clients a bit hesitant when it comes to investing in an asset class like REITs. Clients must realize that they can expect to experience losses from time to time when investing in REITs. But with a long investment horizon, losses can potentially be recouped. Five Concerns about Target-Date Funds Testifying before the U.S. Senate’s Special Committee on Aging on Oct. 28, Morningstar vice president of research John Rekenthaler said that the target-date fund industry needs to address five concerns: 1 The wide range of fees charged by the target-date fund families Morningstar tracks. “On the low end, one target-date family has an expense ratio of only 0.19%. On the high end, another has an expense ratio of 1.82%—more than nine times higher than the first family,” Rekenthaler said. “The issue of expenses is particularly important with target-date funds because of their very long time horizons.” 2 The tendency of target-date funds to invest solely in their own company’s underlying funds. “No reputable institutional investor would hand over his or her entire portfolio to a single assetmanagement firm,” Rekenthaler said. “The institutional investor would not expect a single firm to excel at all types of investing. Yet that is implicitly the position taken by most fund families in running their target-date funds.” 3 The lack of manager ownership. “Targetdate funds would seem to be the ideal way for a fund manager to ‘eat his own cooking,’ given that target-date funds are openly marketed as being suitable for every possible type of investor,” Rekenthaler said. “Yet only two out of 58 target-date managers whom we track list $500,000 or more invested in their own funds. Even more strikingly, 33 of the managers, or 57%, show nothing at all.” 4 The variation in glide paths among funds closing in on their retirement dates. Rekenthaler used 2010 funds as an example. “Two fund families have more than 70% of their 2010 funds’ assets placed in equities. Conversely, three families have fewer than 30% of their 2010 investments in stocks. This divergence in asset allocation resulted in a wide difference in performance during the dramatic 2008 market, REIT Risk of Loss over Time 1972–2008 One-year returns 50% 0 Five-year annualized returns 50% 0 Each bar represents the average return for the preceding ﬁve-year time period. 15-year annualized returns 50% 0 Each bar represents the average return for the preceding 15-year time period. 100% 100% Periods with gain Periods with loss 22% 78% 16 Morningstar Advisor December/January 2010
Morningstar Advisor - December/January 2010

Table of Contents for the Digital Edition of Morningstar Advisor - December/January 2010
