The Daily Screen: The Best Real Estate Funds

Ah, real estate funds -- your chance to own a little corner of the world and hide from the market's tempest.

The key selling points of real estate funds, the focus of today's Daily Screen, is that they can be a good diversification tool because they have low correlation with the S&P 500 and they also provide you with a steady income stream. We'll comb through the category for funds with solid track records, but first things first: What are real estate funds and what do they buy?

Real estate funds typically invest in real estate investment trusts or REITs. A REIT is a company that owns a collection of properties and earns most of its income from leases. Like many stocks, REITs need a healthy economy to flourish, but because they don't earn their money from products and services, they don't tend to move in tandem with stocks. (For more on the real-estate sector, check out the latest Analysts Rankings item on REITs: Beneficiaries of the Tech Meltdown.)

Though real estate funds are typically seen as cheap, defensive investments that can stay afloat in tough markets, they are hardly risk-free. In 1998 and 1999, when investors focused almost strictly on growthy stocks in the technology and telecommunications sectors, the average real estate fund lost 15.8% and 3.5%, respectively, according to Morningstar.

With investors fleeing growthy issues this year, the average real estate fund is up more than 16%, thrashing the S&P 500 by more than 20 percentage points. They're also paying a 4.1% yield over the past 12 months, more than four times that of the S&P 500, according to Morningstar. But they're tame shows over longer time periods, when they trail the S&P 500 significantly.

Rarely Do the Twain Meet The broader market and real estate funds, a market darling this year, rarely move together
	Avg. Real Estate Fund	S&P 500
YTD	16.2%	-5%
1-Year	20.6	7.2
5-Year	9.5	20.9
10-Year	10.5	18.9
Source: Morningstar. Annualized performance figures through Oct. 23.

If you're intrigued by the idea of devoting a modest percentage of your portfolio to real estate and don't mind the taxes entailed in an income-producing investment, we've tried to develop a list of funds you might consider. We sifted the real estate fund pack for those funds that beat their average peer over the past one- and three-year periods; here's the top 10 ranked by one-year return.

Hot Properties Among real estate funds that topped their peers over the past one- and three-year periods, these 10 have the highest one-year returns
Real Estate Fund	1-Year Return	3-Year Return
(PHRAX Quote)Phoenix-Duff Real Estate	33.1%	1.4%
(SUSIX Quote)Security Capital U.S. Real Estate	28.4	4.4
(REITX Quote)Phoenix-Seneca Real Estate	26.5	-1.5
(FRESX Quote)Fidelity Real Estate	26.5	-0.6
Flag Investors Real Estate	26.2	-1.9
(FARCX Quote)First American Real Estate	26.0	0.7
(CGMRX Quote)CGM Realty	26.0	0.0
(CSRSX Quote)Cohen & Steers Realty	25.5	0.3
(DPREX Quote)Delaware REIT	25.4	2.1
Victory Real Estate	23.5	2.1
Avg. Real Estate fund	20.5	-2.0
S&P 500	7.2	15.0
Source: Morningstar. Annualized performance figures through Oct. 23.

If you're looking for the manager with the most experience, you might check out the no-load (CSRSX Quote)Cohen & Steers Realty fund, where Martin Cohen and Robert Steers have held the reins since the fund's 1991 inception. Or you might consider the (CGMRX Quote)CGM Realty fund, where Ken Heebner has steered the fund since its 1994 launch.

There are two broker-sold funds on our list with low volatility compared to their peers and a pair of no-load funds, too. The broker-sold duo are Victory Real Estate and (DPREX Quote)Delaware REIT. The less risky no-load choices are the (SUSIX Quote)Security Capital U.S. Real Estate fund and the (FARCX Quote)First American Real Estate fund.

If you're a die-hard indexer, Vanguard does offer its (VGSIX Quote)REIT Index fund, which tracks the Morgan Stanley REIT Index and was launched in 1996.

As you might expect, the fund's 0.33% expense ratio is well below the category's 1.71% average, but it hasn't been a stellar performer. Its 1.5% loss over the past three years is just ahead of its average peer, but the fund lagged its average peer in 1997, 1998, 1999 and so far this year, despite a respectable 15.7% gain since Jan. 1, according to Morningstar.