- Recent article inspired a review of historical records to see if Cohen & Steers should be considered a "master of the universe".
- Compared two Cohen & Steers domestic real estate funds against Vanguard's REIT.
- The results indicate that, perhaps, Cohen & Steers should abdicate the throne.
Articles such as the recent post on Seeking Alpha that referred to Cohen & Steers as the "King of REITs" stir my interest - though, perhaps, not in a typical way. The article noted that "Cohen & Steers has been around since 1986 and is the first investment company to specialize in investing in listed real estate securities." It also noted that about two-thirds of its $49 billion it had under management at the end of the first quarter of 2014 were invested in real estate-related securities.
My interest in such articles is to check the historical record to see if, in fact, a fund manager or fund family should be considered one of those "masters of the universe" who persistently generate alpha, outperforming their appropriate benchmarks. I was particularly interested in Cohen & Steers because prior to making the switch in 1995 to using passively managed funds (such as index funds), my firm, Buckingham, had used Cohen & Steers for allocations to REITs. With that in mind, let's take a look at how the "King of REITS" has done - knowing that hindsight is 20/20 (we know today that perhaps Cohen & Steers is the "King," but 20 years ago, we couldn't have known with certainty that it would become the king).
Cohen & Steers runs two domestic real estate funds, the Cohen & Steers Real Estate Securities A (CSEIX), which has an expense ratio of 1.23 percent, and the Cohen & Steers Realty Shares (CSRSX), which has an expense ratio of 0.97 percent. Its website shows the same objective for both funds: "The investment objective of the Fund is to achieve total return through investment in real estate securities. Real estate securities include common stocks, preferred stocks and other equity securities of any market capitalization issued by real estate companies, including real estate investment trusts (REITs) and similar REIT-like entities."
To see if Cohen & Steers deserves the title of "King," we'll compare the performance of its two funds to Vanguard's REIT (VGSIX). Using Morningstar data as of May 16, 2014, we'll examine returns of the three funds for the latest 5-, 10-, and 15-year periods. We'll also look at the average return of the two Cohen & Steers funds.
Annualized Return 10 Years
Annualized Return 15 Years
Cohen & Steers Average
Over the latest 15-year period, while CSRSX outperformed Vanguard's index fund by 0.50 percent a year, CSEIX underperformed it by 0.52 percent a year, leaving the average return for the two Cohen & Steers funds in basically a tie with VGSIX. Not exactly a king-like performance - not unless you want your king to be sharing his crown with an index fund that supposedly just gets you average returns.
Over the latest 10-year period, while CSRSX outperformed Vanguard's index fund by 0.74 percent, CSEIX underperformed it by 1.48 percent, leaving the average return of the two Cohen & Steers funds underperforming VGSIX by 0.37 percent - not even a princely performance.
Additionally, over the latest five-year period, while CSEIX outperformed VGSIX by 0.05 percent, CSRSX underperformed by 1.19 percent, producing an average underperformance of 0.57 percent.
What conclusions can we draw from the data? First, while CSRSX did outperform both its sister fund CSEIX and the VGSIX over the 10- and 15-year periods, it trailed both by over 1 percent a year over the last five years. Investors basing their decisions on the past performance of actively managed funds would have learned why the SEC disclaimer -- on past performance not being prologue -- is required.
Second, it's worth noting that Cohen & Steers' underperformance was less than the difference in expense ratios. VGSIX has an expense ratio of 0.24 percent. The expense ratios for CSEIX and CSRSX are 1.23 percent and 0.97 percent, respectively. Thus, we can conclude that more than 100 percent of Cohen & Steers' underperformance was related to expenses. In other words, while the firm exhibited stock picking skills, the skill level wasn't sufficient to overcome the burden of the higher expenses. That's the overall evidence on active management finds. Actively managed mutual funds do exhibit some stock selection skills, just not enough to overcome all of the incremental expenses (not just the higher expense ratios, but higher trading costs as well).
Third, if the "king" of REITs, on average, hasn't outperformed the simple REIT index fund, then perhaps the markets in REITs, while not being perfectly efficient, are efficient in the only sense that really matters -- are active managers likely to outperform after the expenses of the effort? At least in the case of REITs, the evidence indicates that active management is just as much a loser's game for investors in this asset class as it is in others. The Vanguard REIT fund has a Morningstar percentile ranking of 18 for the last five years, 37 for the last 10 years, and 34 for the last 15 years. Thus, it outperformed a large majority of actively managed funds over each of the periods. And that's without even considering that the Morningstar data contains survivorship bias. Poorly performing funds that didn't survive the full period are not included in the rankings. If they had been, VGSIX's rating would have been considerably higher.
Is it possible for actively managed funds to outperform appropriate benchmarks? Of course it is. And given the large number of funds trying, even randomly (by pure luck) we would expect some to succeed. However, even in the presence of skill, successful active management contains the seeds of its own destruction, as cash flows that follow outperformance make it more difficult to generate alpha. And perhaps the prior success of CSRSX and its increasing AUM is what led to its underperformance in the last five years. And if you own that fund, now what do you do? Do you hope it will return to its former glory, and if so, how long do you wait? Unfortunately, there's no good answer to that question. And that is one of the problems for active investors. The evidence on pension plans that use active managers demonstrates that the managers they fire go on to outperform the majors they hired to replace them - another demonstration of past performance not being a predictor of future performance.
It's worth noting that investors seem to becoming wiser. Today, Vanguard's domestic REIT index fund (VGSIX), with $41 billion in assets, manages more REIT assets than all the global real estate assets that Cohen & Steers has combined. In other words, if Cohen & Steers was ever "king," it appears that the king has been dethroned.