An Active ETF for a Real Estate Minefield?

 |  Includes: IYR, PSR, VNQ
by: Shishir Nigam

On August 24th, US existing home sales plunged by 27%. Consensus expectations were for the number to be around 4.72 million, which in itself was a decrease from the previous number of 5.26 million, though the actual home sales in July came out at 3.83 million, the lowest number in 15 years. When expectations are missed by such a margin, everyone starts questioning their assumptions.

The chart below, courtesy of Zero Hedge, says it all: (Click to enlarge)

This latest reading on the US housing market probably confirms in many people’s minds that the supposed recovery is not going to be as smooth and V-shaped as many were hoping for in 2009.

With the real estate sector being such a drag on the US economy, it’s hard to see this as reflecting anything but poorly on the future prospects of the US real estate market. That’s where the “contrarian” investor in many people would say now would be a good time to make long bets on the US real estate market, after all, how much lower could it go? However, a naive line of thinking precisely like that could bring significant risks along with it. Any investors betting on the real estate sector now would have to pick their bets wisely, and avoid catching onto any falling knives.

Traditionally, investors have chosen to get exposure to the US real estate market through ETFs like the Vanguard REIT ETF (NYSEARCA:VNQ) the largest real estate ETF, which follows the MSCI REIT Index and cover about two-thirds of the entire US REIT market. Another popular alternative is the iShares Dow Jones U.S. Real Estate Index Fund (NYSEARCA:IYR), which follows the Dow Jones US Real Estate Index, and is the second largest real estate ETF in the US. And investors would generally have been satisfied with the performance of these ETFs so far, with VNQ returning a very solid 53.90% over the last year (through July 31st) and IYR returning 49.44% over the same period. However, it would be naive to expect similar performance going forward, especially after the weakness that has been confirmed by today’s data number.

A case can be made for the need for active management in the REITs sector, especially given the minefield that the US real estate sector is likely to represent going forward. Holding a passive can be useful to the extent of providing you with the broadest exposure possible, though as an investor, you would end up holding all the component securities in the index, whether bad or good. In contrast, an active manager would be able to apply some discretion with regards to which securities they choose to hold and would be able to take into account the fundamental quality of the securities.

An actively-managed ETF that provides investors with that possibility is the PowerShares Active U.S. Real Estate ETF (NYSEARCA:PSR). This fund is actively-managed by Invesco PowerShares and invests in securities selected from those included in the FTSE NAREIT Equity REITs Index (FNER). The lead portfolio manager, Joe V. Rodriguez, selects securities by using quantitative and statistical metrics to identify attractively priced securities and manage risk. PSR has total expenses of 0.80%, so investors will definitely be paying a premium over index ETFs, but PSR has shown the performance to justify the expenses. Since the fund's inception in November 2008, PSR has been able to return 53.3% as of June 30, 2010, compared to the FTSE NAREIT Equity REITs Index's return of 33.1% and the S&P500's 11.8% in that period. A graphical comparison of the PSR fund to the Vanguard REIT Index and the iShares Dow Jones U.S. Real Estate Index Fund highlights the outperformance:

Disclosure: No positions in above-mentioned names.

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