The Role of REITs for Long-Term Investors
by Brad Case
The German statesman Konrad Adenauer was quoted as saying “We all live under the same sky, but we don’t all have the same horizon.”
That’s certainly true of investors: We all live among the same set of assets, but how we combine them into an investment portfolio depends on our own circumstances—including our investment horizons.
In this article
- Stock Correlations Move Closer Over Time
- REIT Correlations Widen Relative to Stocks
- Implications for Portfolio Management
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To simplify, we might say there are two types of investors. The first type—call them tactical—pays attention to short-term fluctuations, hoping to identify opportunities to buy undervalued assets or to sell overvalued ones. Tactical investors play an active role in identifying mispricings and trading in a way that tends to eliminate them. For tactical investors, correlations among asset classes are less important than current valuations—and volatility may actually be good, because it creates trading opportunities.
The second type of investor—call them strategic—doesn’t have time to look for short-term mispricings; instead, they structure a well-diversified portfolio and take advantage of the interactions among their assets—that is, the power of diversification—to reduce the likelihood of a hit that would affect the entire portfolio. Strategic investors have a long investment horizon: Current valuations are less important than low long-term correlations and strong long-term risk-adjusted returns.
It’s not surprising that the investment characteristics of particular assets change over time: For example, return volatility for publicly traded real estate investment trusts, along with most or all other assets, spiked during the credit crisis of October 2008–March 2009. (REIT volatility rapidly declined to normal levels after the crisis ended, however.) What is more surprising, though, is that investment characteristics may also change over different investment horizons. If that’s the case, then you can potentially make better portfolio decisions by understanding investment characteristics at your own most relevant horizon.
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