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Real Estate Funds May Help You Diversify

Real estate funds don’t invest in bomb shelters but, just the same, they do offer some degree of protection against stock market shocks. Both before and after Sept. 11, bricks and mortar plays have been holding up better than diversified equity funds.The average real estate fund has returned 12.4 per cent in the 12 months ended in August. By comparison, the average Canadian equity fund is down 14 per cent over the same period. More recently, from the end of August up until early this week, real estate funds haven’t been immune from the market decline. As a group, however, these income-oriented funds have lived up to their reputation for below-average volatility.As well, real estate is an inflation hedge, an attractive feature at a time when war-minded governments are increasing spending, easing off on monetary policy and putting tax cuts on the back burner.Real estate, because of its defensive characteristics, has garnered a lot of deserved praise from asset-allocation experts. In an article earlier this year in the Canadian Investment Review, Victor Li of the Ontario Teachers’ Pension Plan Board investment team concluded that real estate provides investors with better inflation protection than either stocks or bonds.Li also said balanced-fund managers who add real estate can reduce their risk while achieving the same return as a portfolio consisting solely of stocks and bonds.If you’re a member of a huge pension plan that has diversified into real estate, you can just sit back and expect to benefit from this when you retire. But if you are investing for your own account, the role of real estate is less clear.By holding real estate, you give up growth potential. In the 10 years ended Aug. 31, for instance, the average Canadian and U.S. equity fund has returned a compound annual 9.7 per cent and 11.8 per cent respectively, compared with only 2.9 per cent on average for the two real estate funds with decade-long track records.

For that reason, any decision to invest in real estate funds, real estate investment trusts listed on stock exchanges or other real property should be based on the over-all composition of your household net worth.If you’re a renter who has no real estate holdings, and are well represented in core asset classes such as Canadian equities, U.S. and overseas equities and bonds, then a small portion devoted to the real estate sector makes sense.

But if you’re a homeowner, real estate may already be the single largest component of your net worth.Consequently, an even bigger stake in real estate, even if it’s commercial or industrial property, won’t deliver the same degree of diversification as would investing in equities and bonds. Another concern is the lack of choice available in real estate mutual funds, and their generally small size. Leaving aside different versions of the same fund, the real estate category has only about 10 distinct portfolios.The number shrinks even further to about a half a dozen funds if you don’t want a fund that’s packaged as a life insurance contract, or a proprietary product available from only one firm.Of the remaining widely available open-end real estate funds, the greatest flexibility for investors in registered retirement savings plans is offered by three funds that invest mainly in Canadian real estate and that are fully eligible for registered plans. They are CIBC Canadian Real Estate, Dynamic Canadian Real Estate and Sentry Select Real Estate Securities.The disadvantage of these funds is that they are compelled to invest mainly in Canadian real estate companies. Unlike managers who can pick freely from among the full global real estate universe, the domestic funds have fewer ways to try to add value.The three real estate mutual funds with potentially the greatest diversification benefits for Canadian investors are the three global ones: AGF Global Real Estate, Dynamic Real Estate Equity and Mackenzie Universal World Real Estate.Of the three, the Dynamic fund is somewhat of a hybrid between a domestic and a global play because the fund recently held 27 per cent of its assets in Canadian real estate. On a positive note, with $50.5 million in assets at the end of August, the fund also has more scope to invest than either the $3.4 million AGF fund or the $7.5 million Mackenzie product.Still, all three of these funds are pretty small, as is the real estate category as a whole. This reflects the fact that real estate funds are the least psychologically fulfilling type of property investment to own.If your house didn’t go up much in value over the past decade, you at least got to live in it. You couldn’t say the same for a real estate fund.