The Daily Screen: The Best Real Estate Funds

They're a good defensive play in a volatile market.
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Real estate funds might not have eye-popping long-term returns, but they can be a port in a stormy market like this one.

Real estate funds, the focus of today's

Daily Screen

, can be a good way to diversify your portfolio because they don't tend to rise and fall with the

S&P 500

index. They also offer a steady stream of income, which can help keep your portfolio afloat when stock prices head south. We'll take a look at the leading real estate funds over the past three years and some of their top picks, but first let's walk through what these funds buy.

Real estate funds usually invest in real estate investment trusts, or REITs. A REIT is a company that owns a collection of properties and earns most of its money from leases. Like many stocks, REITs need a healthy economy to grow their earnings.

If you're intrigued by the idea of a defensive, income-producing stock investment, a real estate fund might make sense for a modest portion of your portfolio. We've sifted the category, screening for real estate funds that beat their average peer over the past one- and three-year periods. Here's a top 10 list, ranked by one-year returns.

As these returns show, real estate funds can do well in a tough market. If you're interested in a fund with steady management, you might consider the

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CGM Realty Trust, where Ken Heebner has been at the helm since the fund's 1994 inception. That said, Heebner's fund tends to have more volatility than most of its peers, and most real estate fund investors are looking for a more steady-Eddie approach.

Two no-load funds on this list with low volatility compared with their peers are the

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Security Capital U.S. Real Estate fund and the

(FREAX) - Get Report

First American Real Estate fund. The broker-sold

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Delaware REIT fund also has experienced fewer bumps than its average competitor, according to

Morningstar

.

Looking for lower volatility and tenured management? You might check out the

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Cohen & Steers Realty fund, which barely missed our cut. Martin Cohen and Robert Steers have run the fund since its 1991 inception, and the fund hasn't hit more bumps than other real estate funds on their watch.

If you're an index-fund investor, check out the

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Vanguard REIT Index fund, which tracks the

Morgan Stanley REIT Index

. Though the fund hasn't looked too solid vs. its peers, it's up 16.6% so far this year, and its 0.33% annual expense ratio is much lower than the category's 1.68% average.

Before you add one of these funds to your portfolio, keep in mind that over the long term they tend to lag the market. Over the past 10 years, for instance, the average real estate fund's 11% annualized return trails the S&P 500's by more than 7 percent.

They're also not risk-free. The average real estate fund finished four calendar years in the red during the 1990s. In 1998 and 1999, they fell 15.8% and 3.5%, respectively, according to Morningstar.

If you'd rather just buy REITs on your own, a look at the top-10 holdings among these 10 leading funds highlights some candidates, including

Equity Office Properties

(EOP)

. All the leading funds held the stock, as of their most recent portfolio reports.