Investors pile in as REITs move closer to S&P 500 sector status

The eleventh sector of the index alters the dynamics of the financial sector

Sep 15, 2016 @ 12:01 am

By Jeff Benjamin

The establishment of real estate as an eleventh sector of the S&P 500 Index is morphing into a near-term investment strategy, according to some market watchers.

The real estate play, ahead of REITs' elevation to sector status on Friday, is seen in the $1.09 billion invested into real estate exchange-traded funds in August, which followed the $1 billion worth of flows in July.

The rush of flows into the real estate ETFs is twofold, according to Christian Magoon, chief executive of Amplify ETFs.

“There are groups that are going to be mandated to have market-weighted exposure to every sector, but part of it also is the additional income that real estate offers compared to the financial sector,” he said.

The real estate sector, primarily represented by real estate investment trusts, will be among the smallest index weightings at around 3%. But that slice is being carved out of the financial services sector, where real estate currently represents about 20% of the 16% financial-sector weighting.

Separating real estate from financials will bring the financial sector down to an index weighting of around 13%, and will also make it a lower-yielding growth-type sector.

“With REITs included, the financial sector is more of a defensive play, but financials ex-REITs will have a lower yield and will exhibit more growth characteristics,” said Todd Rosenbluth, director of mutual fund and ETF research at S&P Global Market Intelligence.

“Part of the appeal of REITs is they offer above-average and steady income, U.S.-centric operations, and they are benefitting from an improving economy,” he added. “REITs have been their own investment style for a long time, and I'm happy to see it becoming a separate sector.”

The income play is illustrated when considering the 3.19% 30-day yield on the Real Estate Select Sector SPDR ETF (XLRE). That compares to a 30-day yield of 1.97% for the Financial Select Sector SPDR ETF (XLF) , which is currently benefitting from REITs still being included in the sector.

According to Mr. Rosenbluth, passively managed securities providing exposure to U.S. real estate had $54.46 billion in assets at the end of August.

The largest ETF in the space, Vanguard REIT Index (VNQ) at $35.39 billion, had $311.5 million in net inflows in August.

The creation of the real estate sector was first announced last year, but Mr. Magoon of Amplify ETFs said the category could continue to benefit as institutional investors adjust portfolios to meet their mandates regarding sector exposure requirements.

“This says there is enough market cap in REIT stocks for them to be a standalone sector, and I think REITs should benefit as a standalone sector, but it might be at the expense of the financial sector,” he said.

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