West Loop Realty Fund White Paper
Role of Active Real Estate Investment Trust (REIT) Managers in Investor Portfolios
Investors have the ability to choose between passive investments or actively managed investments for their REIT-dedicated allocation. Passive investments typically have lower fees than active investments, and may provide diversified exposure to commercial real estate.
Dissecting Index Returns
The chart below shows how various asset classes performed on a year-by-year basis from 2005 through 2014. The best-performing asset class for each year is at the top of each column. Note that the indices below do not represent the performance of the West Loop Realty Fund. Past performance is no guarantee of future results.
The Vanguard REIT ETF (NYSE: VNQ) has grown dramatically over the past three years from $8.7 billion to $21 billion as of March 31, 2014. This passive exchange traded fund (ETF) has performed as advertised, delivering total returns near, but never significantly above, its benchmark.
Though REITs are an asset class and their historical benefits are measured in performance of a representative index, the underlying property type sectors can have a wide range of returns over any given period (see Figures 1A & 1B). For example, the self-storage sector had a total return of +5% in 2008 while industrial REITs were down -67%. In 2013, lodging had a total return of +27% while health care REITs were down -7%.
Each property type has its own supply and demand drivers, which can alter the duration and direction of its unique cycle. In hindsight, it seems obvious that the decline of the single-family homeowner as housing prices fell in 2008 and 2009 would be a boon for apartment owners. But was it possible to see coming? On Camden Property Trust’s (NYSE: CPT) 3Q 2009 earnings call, CEO Ric Campo gave the reasons why the multifamily business was going to excel: “First, the reduction in the homeownership rate by 1.8 percentage points has created two million new renters. Second, multifamily supply peaked at the beginning of the downturn. Third, is that demographics are better.” CPT was renewing tenants at 3% higher rents than the expiring rate while other property types were experiencing negative growth. The NAREIT Apartment Index (Bloomberg: FNAPT) produced a +47% return in 2010, which compared to +28% for the MSCI US REIT Index.
While owning significantly more than the benchmark in certain property types has the opportunity to result in outperformance or underperformance, simply not owning REITs in a sector can be just as influential. In the four periods of rising interest rates since the start of the modern REIT era in 1992, health care REITs have averaged the second worst total returns of all property types because of their long lease durations. On May 22, 2013, Ben Bernanke gave a speech indicating that he would begin tapering bond purchases sooner than investors were expecting. His speech drove the 10 Year US Treasury yield from +2.04% on May 22 to +3.03% on December 31, 2013. Over the same period, health care REITs (Bloomberg: BBREHLTH) were down a whopping -27%!
Management Teams Matter, Too
In the seven-year period from June 2006 to June 2013, which incorporates a full property cycle, the NAREIT Equity REITs Index (FNER) produced a total return of 42%. However, the top ten REITs over that time period averaged a total return over 200%, while the bottom ten averaged worse than -60%! (See Figure 2)
Similar to conducting property type research, active managers can analyze management track record, operational experience, and balance sheet flexibility to identify potentially under-appreciated individual REITs in an attempt to avoid those where the risk outweighs the potential return. A management team’s principal goal should be to grow Net Asset Value (“NAV”) in a responsible and prudent manner while being poised to maintain a growing dividend to investors.
The cash flow generated by a portfolio of properties requires management teams and boards of directors to be especially astute at capital allocation. If a company can prove itself over a full cycle, investors will take note of this performance. The opposite will occur if a company is too aggressive with its balance sheet or external growth.
ExtraSpace (NYSE: EXR), a self-storage REIT, benefited from a 40% gain in its property values from June 2006 to June 2013 according to Green Street Advisors. Along the ride, management grew NAV even further as a result of smart capital allocation and maintaining a flexible balance sheet. Investors benefited as well, receiving a 275% return over the seven-year period.
In contrast, General Growth Properties (NYSE: GGP) enjoyed a 20% appreciation in its properties over the same period, but the stock decreased by almost 30%. Their leverage, a lack of laddered debt maturities, and the closing of the capital markets in 2008 caused the company to file for bankruptcy despite experiencing healthy growth in its property values.
Role of an Active REIT Manager
Though REITs are subject to volatility from changes in sentiment, the liquidity, dividends, regulatory oversight, typically lower fees, and high management ownership seem to make them a real estate investing opportunity for most investors. Active managers have the ability to take advantage of short-term volatility to buy REITs at a discount to their long-term intrinsic value. Fees differ by fund and by share class, and we believe that active REIT managers have a good chance of outperforming their index, while passive ETFs have a slimmer chance. The disparity of returns between property types and even individual companies may provide the tools that enable them to help minimize downside risk while potentially aiding returns all while staying at or near fully invested.
The REIT structure in the public form has proven its ability to attract intelligent capital, and smart management teams have followed. However, some are better than others, and each property type has a different cycle. REITs’ valuation metric known as NAV and the transparency afforded via disclosures and face to face meetings with decision-makers have created an environment in which active management have the ability to outperform a passive ETF.
West Loop Realty Fund | As of December 31, 2014
|Total Return (net of fees)||1 Month||Q4||YTD||1 Year||Annualized ITD*||Cumulative ITD*|
|REIAX w/ Load||-4.48%||6.52%||22.83%||22.83%||22.83%||22.83%|
|MSCI US REIT Index||1.93%||14.34%||30.38%||30.38%||30.38%||30.38%|
Performance data quoted represents past performance and is no guarantee of future results. Total return figures include the reinvestment of dividends and capital gains. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. For the most recent month end performance, please call (800) 207-7108. Returns showing less than one year are cumulative. *ITD represents inception-to-date data. The Fund’s inception date was 12/31/2013. The gross operating expense ratio for the Class A, C, and Institutional Shares are 2.84%, 3.59% and 2.59%, respectively. The Fund’s investment advisor contractually agreed, until April 30, 2015, to waive its fees and/or pay operating expenses so that the net expense ratios of the Class A, C and I Shares do not exceed 1.50%, 2.25% and 1.25%, respectively. Otherwise, performance shown would have been lower. Performance results with load reflect the deduction for Class A Shares of the 5.75% maximum front-end sales charge. Class C Shares are subject to a contingent deferred sales charge of 1.00% when redeemed within 12 months of purchase. Performance presented without the load would be lower if this charge was reflected. Fund performance may be subject to substantial short-term changes.
As of September 30, 2014, the last date of Fund portfolio holdings were publicly available, the following securities mentioned in this Commentary maintained the following percentages of Fund assets: Camden Property Trust (CPT) 4.44%, ExtraSpace Storage Inc. (EXR) 3.34%, and General Growth Properties (GGP) 2.16%.
As of September 30, 2014 the following security mentioned was not a fund holding: The Vanguard REIT ETF (NYSE: VNQ)
Sources for Figure 1A: NAREIT, Bloomberg, Federal Reserve Bank of St. Louis and KeyBanc Capital Markets, Inc. Storage, Malls, Industrial, Apartments, Office, Lodging, Strips, Healthcare, Free Standing and Manufactured Homes are represented by the FTSE NAREIT Sub Sector Classifications; FTSE Eq REIT is represented by the FTSE NAREIT US Equity REITS Index; “BBB” is represented by the Bank of America Merrill Lynch US Corp 10-15yr Total Return Index; and the S&P 500 is represented by the S&P 500 TR. One cannot invest directly in an index.
Sources for Figure 1B: Past performance is not indicative of future results. NAREIT, Bloomberg, Federal Reserve Bank of St. Louis and KeyBanc Capital Markets, Inc. Storage, Malls, Industrial, Apartments, Office, Lodging, Strips, Healthcare, Free Standing and Manufactured Homes are represented by the FTSE NAREIT Sub Sector Classifications; FTSE Eq REIT is represented by the FTSE NAREIT US Equity REITS Index; “BBB” is represented by the Bank of America Merrill Lynch US Corp 10-15yr Total Return Index; and the S&P 500 is represented by the S&P 500 TR. One cannot invest directly in an index.
Definitions of Indices Used
The FTSE NAREIT Equity REIT Index (FNER) is designed to present investors with a comprehensive family of REIT performance indexes that span the commercial real estate space across the US economy, offering exposure to all investment and property sectors. In addition, the more narrowly focused property sector and sub-sector indexes provide the facility to concentrate commercial real estate exposure in more selected markets. Inception Date 3/1/2006. RISKS: real estate industry concentration risk (non-diversification), interest rate risk (as interest rates rise bond prices usually fall), the risk of issuer default, and inflation risk exist.
The S&P 500 Index has been widely regarded as the best single gauge of the large cap U.S. equities market since the Index was first published in 1957. The Index includes 500 leading companies in leading industries of the U.S. economy, capturing 80% coverage of U.S. equities. Inception Date 3/4/1957. RISKS: can be affected by general market or economic conditions.
The Bank of America Merrill Lynch US Corp 10-15yr Total Return Index tracks the performance of US dollar denominated investment grade rated corporate debt publicly issued in the US domestic market. This subset includes all securities with a remaining term to maturity of greater than or equal to 10 years and less than 15 years. When the last calendar day of the month takes place on the weekend, weekend observations will occur as a result of month ending accrued interest adjustments. Inception Date 3/31/1976. RISKS: Currency risk, inflation risk and the risk of issuer default exist.
The MSCI US REIT Index is a free float-adjusted market capitalization weighted index that is comprised of equity REITs that are included in the MSCI US Investable Market 2500 Index, with the exception of specialty equity REITs that do not generate a majority of their revenue and income from real estate rental and leasing operations. The index represents approximately 85% of the US REIT universe. RISKS: Real estate industry concentration risk (non-diversification), interest rate risk (as interest rates rise bond prices usually fall), the risk of issuer default, and inflation risk exist.
One cannot invest directly in an index.
Effective September 30, 2014, the Fund changed its fund name from “Chilton Realty Income & Growth Fund” to “West Loop Realty Fund.” Chilton Capital Management, LLC remains as the Fund’s sub-advisor. The Fund’s investment objective, principal investment strategies and principal risks remain the same.
Before investing you should carefully consider the West Loop Realty Fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus and summary prospectus, a copy of which may be obtained by calling 800-207-7108 or by visiting the Fund’s website at www.westlooprealtyfund.com. Please read the Fund’s prospectus and summary prospectus carefully before investing.
RISKS AND OTHER DISCLOSURES:
An investment in the West Loop Realty Fund is subject to risk, including the possible loss of principal amount invested and including, but not limited to, the following risks, which are more fully described in the prospectus:
- The Fund invests in Real Estate Investment Trusts (REITs), which involve additional risks compared to those from investments in common stock. REITs are dependent upon management skills; generally may not be diversified; and are subject to heavy cash flow dependency, defaults by borrowers, self-liquidation, and tax risks.
- Investments in REITs involve risks including, but not limited to, market risk, interest rate risk, equity risk and risks related to the real estate market.
- The Fund will be closely linked to the performance of the real estate markets. The Real Estate industry is subject to certain market risks such factors as property revaluations, interest rate fluctuations, rental rate fluctuations and operating expenses, increasing vacancies, rising construction costs and potential modifications to government regulations.
- REITs are subject to declines in the value of real estate risks related to general and local economic conditions and decreases in property revenues. Continued disruptions in the financial markets and deteriorating economic conditions could adversely affect the value of the Fund’s investments.
- As a non-diversified fund, the Fund may focus its assets in the securities of fewer issuers, which exposes the Fund to greater market risk than if its assets were diversified among a greater number of issuers.
- The Fund’s investments will be concentrated in the real estate sector. The focus of the Fund’s portfolio on a specific sector may present more risks than if the portfolio were broadly diversified over numerous sectors.
- Foreign investment risk. These risks include currency fluctuations, economic or financial instability, and lack of timely or reliable financial information or unfavorable political or legal developments. Foreign companies are generally subject to different legal and accounting standards than U.S. companies.
- The Fund invests in small and mid-cap real estate companies, which may involve less trading and, therefore, a larger impact on a stock’s price than customarily associated with larger, more established company stocks.
- The Fund is newly organized and has a limited operating history. As a result, prospective investors have a limited track record or history on which to base their investment decisions.
- In order to qualify for the favorable tax treatment generally available to regulated investment companies, the Fund must satisfy certain diversification requirements. The Fund’s strategy of investing in a relatively small number of securities may cause it inadvertently to fail to satisfy the diversification requirements. If the Fund were to fail to qualify as a regulated investment company, it would be taxed in the same manner as an ordinary corporation, and distributions to its shareholders would not be deductible by the Fund in computing its taxable income.
Diversification does not assure a profit or protect against a loss in a declining market. The Fund may not be suitable for all investors. We encourage you to consult with appropriate financial professionals before considering an investment in the fund.
Distributed by Foreside Fund Services, LLC. www.foreside.com