Many retail investors remain underexposed to REIT stocks despite the diversification benefits they can provide to investment portfolios, according to a study from Fidelity Investments Research.
Co-authored by investment managers Andy Rubin, Steve Buller, and Sam Wald, the paper argues that investors should consider higher exposures to commercial real estate through listed REITs. In particular, it looks at the role that REITs play in multi-asset class portfolios with longer-term strategic objectives.
The authors observed that despite the proliferation of REITs in major equity market indexes, equity fund managers on average have remained underweight on REITs for the majority of the past decade. Looking at all market capitalizations, value-oriented equity funds have maintained the largest underexposure to REITs. Fidelity’s analysis also showed that fund managers across all three market capitalizations—small, mid and large—have tended to allocate less capital to REITs over time.
Possible reasons for this lack of exposure, the authors contend, include a general lack of understanding among equity portfolio managers about how to value REITs, a lack of research depth devoted to REITs and liquidity concerns, given the relatively smaller market capitalization of the asset class.
Fidelity’s investment managers maintain that investors who utilize passively managed equity strategies that track major indexes may have adequate exposure to REITs that can provide an optimal level of diversification. However, investors who employ actively managed equity strategies may want to take a closer look at underlying REIT exposure to determine whether their allocation is adequate, according to the report.
While many retail investors have been underexposed to REITs, the report noted that institutional investors have long embraced commercial real estate as a core asset class. Eighty-one percent of U.S. pension plans with assets exceeding $50 billion hold some level of publicly listed real estate exposure, according to Fidelity’s research.
“The institutional side is definitely more positive, Rubin said. “They are less affected by the shorter term. They are looking at the asset class a little bit more strategically now than I think we’ve seen in some time.”
According to the report, the compelling influence of REITs on a portfolio’s diversification is due in large part to the “imperfect performance correlation” between REITs and U.S. stocks and investment-grade bonds over the past 20 years. Fidelity’s analysis found that an allocation to REIT stocks would have boosted the risk-adjusted returns of a portfolio including stocks and investment-grade bonds during that time period.