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The Independent Adviser for Vanguard Investors
•
November 2015
•
7
FOR CUSTOMER SERVICE, PLEASE CALL
800-211-7641
IT’S BEEN A LACKLUSTER
first five
years for
Global ex-U.S. Real Estate
Index
. Investors in the fund, which
launched on Nov. 1, 2010, have sacri-
ficed returns when diversifying away
from
REIT Index
—and have only
recently seen a small reduction in risk.
Anyone who expected more in the form
of diversification has been disappointed.
Any way you slice the data, in a
head-to-head comparison, REIT Index
has dominated Global ex-U.S. Real
Estate Index. Since inception, the latter’s
28.0% return trails REIT Index’s 74.3%
gain. But it’s not just about the returns;
REIT index has delivered those supe-
rior returns with equal or lower risk—
depending on how you want to calculate
it. Over the past five years, both real
estate index funds had a standard devia-
tion (a measure of volatility) of 16%.
That’s what I call the “Greek alphabet”
of risk. But what about how risk impacts
your portfolio’s value? Let’s consider
rolling returns. Twelve-month returns
for the global fund have ranged from
-16.7% to 41.5% compared to a range
of 0.3% to 33.3% for REIT Index. So, at
its worst, investors suffered double-digit
declines over a 12-month period in the
foreign fund, but never a single losing
year in the domestic fund.
Another way to look at risk is the
maximum drawdown since incep-
tion. Global ex-U.S. Real Estate Index
dropped a full 21.7% between April
2011 and September 2011, while REIT
Index’s worst decline over the same
period was just 17.5%.
It’s a given that there will be years
when overseas real estate investments
will underperform those in U.S. mar-
kets, so that alone isn’t the disappoint-
ment. It is entirely possible Global
ex-U.S. Real Estate Index will win out
over the next five years. Where Global
ex-U.S. Real Estate Index has disap-
pointed is as a diversifier.
Consider a 50/50 mix of the two real
estate funds. Over the past five years,
the 50/50 mix returned 49.4%, lagging
REIT Index because the global fund
underperformed. No surprise there. But
at the very least, the 50/50 investor might
have expected a smoother ride. Alas,
that wasn’t the case: As you can see in
the max cumulative loss chart above,
over the past five years, REITs have
seen three separate corrections, or draw-
downs, of at least 10%, and only once
has there been a diversification benefit to
holding both real estate funds. The first
correction, which I mentioned above,
hit its low point in September 2011 and
saw the 50/50 portfolio decline 19.4%—
worse than REIT Index. The second cor-
rection saw REIT Index decline 13.4%
from April 2013 to August 2013. Over
that stretch, Global ex-U.S. Real Estate
Index fell 13.8% and the 50/50 portfolio
declined 13.6%. Not much diversifica-
tion benefit there, either.
The two real estate funds are pres-
ently working their way out of a third
correction. However, this time around,
the 50/50 blend is holding up better
than either fund is individually. REIT
Index hit a recent drawdown of 13.1%
between January 2015 andAugust 2015.
Global ex-U.S. Real Estate Index hit a
low decline of 12.9% from April 2015
through September 2015. Meanwhile,
the 50/50 portfolio only hit a maximum
decline of 9.5% in August—better than
either of the two components.
How did this happen? Well, over
the past 10 months, the two funds have
not moved in lockstep. For instance, in
February and April when REIT Index
sold off, down 3.6% and 5.9%, respec-
tively, Global ex-U.S. Real Estate
Index gained ground, returning 3.5%
and 5.6%, respectively. The reverse
occurred in July and September as the
foreign fund declined and the domes-
tic fund gained ground. Those months
where the funds went in opposite direc-
tions helped smooth the ride for the
50/50 portfolio.
I am not writing off Global ex-U.S.
Real Estate Index yet. The past five
years have favored U.S. financial assets
in a big way—
Total Stock Market
has
grown 14.0% a year for the past five
years, while
Total International Stock
only grew at a 2.6% pace. When we
see that trend reverse, holding Global
ex-U.S. Real Estate over REIT Index
could look smart, though I’m doubtful
that anyone is going to simply trade
in all their REIT Index shares for an
investment in the global fund. Vanguard
never intended that you choose between
the two. Their argument was that add-
ing non-U.S. real estate holdings was a
smart diversifier.
Unfortunately, the past five years
have mirrored the longer-running his-
torical index returns I looked at before
the foreign fund’s launch. Even then,
I found that adding foreign real estate
to a position in REIT Index reduced
risk a bit. However, the reduced risk
didn’t make up for the returns you had
to sacrifice.
Unless you are a diehard global
diversifier, I wouldn’t rush to diversify
away from REIT Index. I continue to
rate the fund a Hold.
n
REITS
Where’s the Diversification?
Going Global
Hasn’t Muted Risk
3/11
9/11
3/12
9/12
3/13
9/13
3/14
9/14
3/15
9/15
REIT Index
Global ex-US REIT Index
50/50
-25%
-20%
-15%
-10%
-5%
0%
Max Cumulative Loss
Any way you slice
the data, REIT Index
has dominated
Global ex-U.S.
Real Estate Index.