Investing in the Only Thing That Lasts

Land, as Scarlett's dad advised in Gone With the Wind, is the only thing that lasts. He might've added that while real-estate prices fluctuate, the asset class provides a great diversification tool in an investor's portfolio.

Today's Five Winning Funds highlights some choice mutual fund offerings in the real-estate category. More than any other sector -- including tech, all you momentum lovers -- real-estate funds deserve a place in most investors' long-term portfolios.

The category has been a great performer over the past three years. So far in 2002, real-estate and real-estate investment trust, or REIT, funds are up 12%, according to Lipper, a Reuters company. The category has turned in three-year annual returns of 13.4% on average and five-year annual returns of 6.13% on average, according to Lipper. The S&P 500, meantime, is down 10.32% a year over the past three years and down 1.35% a year over the past five years.

Of course, that doesn't mean investors should be jumping into to real-estate funds looking for a quick shot. The sector has been hot, and the hefty dividends offered by many of the funds have kept them buoyant. But as Real columnist Chris Edmonds notes, economic concerns weigh on the office property group, apartment markets look overbuilt in most areas and valuations are a concern.

But the reasons for getting a piece of real-estate funds aren't short-term in nature. Over the long haul, real-estate funds have provided diversification, leading to greater returns and reduced risk levels, according to asset-allocation consultant Ibbotson Associates.

Real-estate funds are especially appealing because of their low correlation to the broader market. REITs moved in tandem with large-cap stocks only 55% of the time from 1972-2000, and the correlation level dropped to 25% from 1993 to 2000, according to Ibbotson. Comparing returns from certain years drives home the point. In 1977, the S&P 500 fell 7.2% and REITs rose 18%. While owning real-estate funds in the late 1990s would have crimped an investor's returns by a few percentage points, over the long haul, real estate has been a boon for the balanced portfolio.

The REIT Mix
Adding a bit of exposure to real-estate investment trusts over the past three decades would have increased an investor's returns while trimming the risk profile of a portfolio.
50% Stocks
40% Bonds
10% T-Bills
45% Stocks
35% Bonds
10% T-Bills
10% REITs
40% Stocks
30% Bonds
10% T-Bills
20% REITs
1972-2000Annual Return 11.8% 12% 12.2%
1972-2000Risk Level 11.2% 10.9% 10.8%
Source: Ibbotson

Without further ado, here are five solid offerings from which to choose in the real-estate fund category.

1. (TRREX) T. Rowe Price Real Estate

The T. Rowe Price Real Estate fund is a safe and sound all-around bet for most investors looking to add real estate to their portfolio.

Among the benefits of the $160 million-in-assets fund: A solid manager in David Lee and the backing of a stellar fund shop in T. Rowe; no load, or sales fee, plus an expense ratio of 1%, below the 1.64% category average; and performance that has consistently outpaced the majority of its peers.

The fund has returned 15.15% a year on average over the past three years and 8.04% a year over the past five years -- placing it in the top 31% and 21% of all real-estate funds, according to Morningstar. The fund's 4.94% dividend yield helps ensure steady returns.

Like most funds in the category, its bets are fairly concentrated: It holds 37 stocks in the portfolio, with top-two holdings Equity Office Properties ( EOP) and Vornado Realty ( VNO) alone making up 11% of the fund, according to Morningstar. However, Lee, at the helm since the fund's 1997 inception, takes a risk-averse, value-oriented approach to the group, which has led to steadier, safer returns than many of the fund's peers.

2. (TAREX) Third Avenue Real Estate Value

The Third Avenue Real Estate Value fund, managed by Michael Winer since its October 1998 inception, aims to sidestep some of the volatility of the boom-and-bust real-estate market by focusing extensively on undervalued stocks.

So far, so good: The $357 million fund has been a consistent outperformer: Its three-year average annual return of 17.19% ranks it among the top 10% of its peers, according to Morningstar. The no-load fund also sports a below-average expense ratio of 1.22%.

While the fund is very concentrated -- the top 10 holdings make up 59% of the fund's assets -- Winer tries to spread the assets around beyond the standard REIT fare, picking up companies from industries such as lumber and hotels, which own substantial real-estate properties. On the downside, the move beyond REITs has kept the fund's dividend yield around 1%. However, Winer so far has shown a knack for picking undervalued companies that have more than compensated.

3. (FRESX) Fidelity Real-Estate Investment

One of the older, bigger and stronger real-estate funds out there is the $1.94 billion Fidelity Real-Estate Investment fund.

While the fund's 10-year average annual return of 9.39% a year puts it smack-dab in the middle among its peers, performance has been more impressive since Steven Buller took the helm in 1998. The fund's 7.75% a year average annual return ranks among the top 27% of real-estate funds, according to Morningstar.

While the fund's hefty assets meant it has had to take fairly large stakes in its bigger holdings -- the top 10 constitute about 50% of the fund -- Buller, a Fidelity real-estate analyst before becoming manager, has demonstrated that he can put his money to work wisely.

The fund is cheap, too: It doesn't charge a sales fee, and the expense ratio is a trim 0.84%.

4. (STMDX) Stratton Monthly Dividend REIT

Investors looking for a novel real-estate fund, as well as one that offers a healthy dose of dividends, might want to take a close look at the $140 million Stratton Monthly Dividend REIT fund.

The fund focuses on smaller-cap, high-dividend-paying REITS, which currently make up more than 80% of its assets. This concentration has spelled greater volatility -- higher highs and lower lows. But the dividend yield of 7.13% is among the best in the mutual-fund world, and returns over the long haul have been solid.

The fund, run by James Stratton since 1980 and co-managed by James Beers since last year, doesn't rank highly over the past 10 years, with its 6.27% average annual return putting it among the bottom 17% of all real-estate funds. The fund's small-cap orientation didn't help in the mid-1990s. However, the 17.8% three-year average annual return and 8.14% five-year average annual return rank in the top 8% and 17%, respectively. The trend of small-cap ascendance and favor for dividend-paying stocks may continue to be friendly to the Stratton Monthly Dividend REIT fund.

The no-load fund carries a below-average expense ratio of 1.03%.

5. Indexer's Choice: (VGSIX) Vanguard REIT Index

The relative merits of using index funds for sector exposure is subject to debate. But for those who opt to buy into a low-cost index fund that tracks the Morgan Stanley REIT Index, the Vanguard REIT Index fund is a solid bet.

The $2.32 billion fund's five-year average annual return of 7.08% places it among the top 43% of its peers. But, as Morningstar points out, the fund actually trails the category average when you go back to the fund's 1996 inception: Vanguard REIT has returned 9.3% a year through March 31, compared with the average 9.8%.

However, the flip side of the coin -- costs -- is where Vanguard leaves competitors in the dust. The no-load fund boasts a mere 0.28% expense ratio.

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