Real Estate Funds Riding High

The cooling residential housing market has taken its toll on homebuilders as new orders fall and cancellations rise. Yet mutual funds that specialize in real estate are still flying high, benefiting from their exposure to commercial property through holdings in real estate investment trusts.

Real estate funds are the top-performing sector this year, returning an average 25.87% through Friday, according to Morningstar. Their annualized returns also top the charts for the past three years at 25.08%, and the past five years at 23.13%.

With some notable exceptions, such as the $260 million (EUEYX Quote)Alpine U.S. Real Estate Equity fund, real estate funds have little or no exposure to homebuilders such as KB Home(KBH Quote), Toll Brothers (TOL Quote) and Pulte Home (PHM Quote).

In some cases, that's a matter of principal. David Lee, manager of the $2.12 billion (TRREX Quote)T. Rowe Price Real Estate fund, has never owned a homebuilder. "Most people already have exposure to residential real estate through their home of their mortgage," he said. "We try to offer them something different."

Investors tend to look to real estate and other 'alternative' asset classes as a means of diversifying their portfolios. For that reason, real estate fund managers typically try to generate returns that have a low correlation to the equity market.

That broader goal doesn't necessarily preclude investments in homebuilders, however.

Joe Rodriguez, manager of the $1.8 billion (IARAX Quote)AIM Real Estate fund, believe these stocks have a role to play in the portfolio, assuming they're priced attractively. "We do look at them from time to time, but we want them to perform a very specific role in the portfolio and only when we feel their risk-adjusted returns warrant consideration," the fund manager said. Rodriquez hasn't owned a homebuilder stock in about a year and a half. While prices have come down quite a bit in the interim, he still believes it's too soon to jump back in.