I was performing some research on the different REIT-focused exchange traded funds and was surprised by some of the recent return results. One newer ETF, the PowerShares KBW Premium Yield Equity REIT Portfolio (KBWY) uses a dividend-centric approach to selecting fund components while the other, broad-market based REIT ETFs are market cap oriented - the bigger companies have the greater weighting and performance effect.
- Vanguard REIT Index ETF (VNQ)
- SPDR Wilshire REIT ETF (RWR)
- Schwab U.S. REIT ETF (SCHH)
- PowerShares KBW Premium Yield Equity REIT Portfolio
Plotting the share prices of the first three listed ETFs back to the start date of SCHH - Jan 2011 - produces essentially identical share price performance. The ETFs have gained 14% in value over the last 16 months. Current dividend yields for the three range from 2.6% for RWR up to 3.3% for VNQ. The higher-yielding Vanguard fund has lagged just slightly in share price return, so total return is a dead heat between the three ETFs. The relatively low-dividend yields when compared with the overall REIT universe is due to the heavy weighting of high-growth, low-yield stocks like Simon Property Group (SPG), Equity Residential (EQR) and Boston Properties (BXP).
The KBW Premium Yield Equity REIT Portfolio ETF uses a different approach to select stocks for the portfolio. Keefe, Bruyette & Woods - which manages the index used - describes the stock selection process (pdf) this way:
The KBW Premium Yield Equity REIT Index is calculated using a dividend yield weighted methodology. The securities comprising the Underlying Index are selected based on their ability to pay income. KBW uses the Adjusted Free Flow from Operations - AFFO - to derive the dividend payout ratios and arrive at the universe of the approximately 24 to 40 best paying small- and mid-cap equity REITs.
The first difference I noticed with KBWY was the significantly higher dividend yield - currently quoted at a distribution yield of 5.13% and a 12-month yield of 5.72%. This means KBWY yields 2.5% to 3% higher than the standard, market cap oriented REIT ETFs. From these numbers, the KBW methodology seems to be working - providing a higher level of income from a REIT ETF. The trade-off appears when you stack the KBWY share price on top of the three REIT ETFs discussed above. Since the start of 2011, the KBWY share value has declined by about 5%. So choosing the REIT dividend yield premium has resulted in almost 20% of share price under-performance since the end of 2010.
KBWY was launched in December 2010 and the fund has only picked up about $9 million in assets, so this analysis is working from a limited amount of data. I was not expecting the yield-focused REIT fund to under-perform the market-cap-focused funds by this amount. The possible lesson to be learned is that the larger REIT stocks are the market leaders not because of their dividend yields but because their businesses continue to grow providing attractive combined returns to investors. Focusing too much on yield could cause investors to miss out on much greater rewards from capital appreciation. I will revisit these results in six months to see if there has been any changes.