In order to illustrate the growing role real estate stocks play in a variety of mutual funds, Fund Focus provides a brief snapshot of a fund and its view on REITs.
In this issue, we profile the Munder Small Cap Value Fund. The fund's team seeks long-term capital appreciation through investments in small-capitalization companies with a stable or improving earnings record and sound finances. Typically, the fund invests in companies that have a market capitalization below $1.5 billion at the time of purchase. REITs make up 12.2 percent of the portfolio, as of Jan. 31, 2003.
Where do you see major market returns heading over the next 12 months?
John Richardson: We are fully invested and believe the upside for the market is substantial, with potential gains of 20 percent plus. Having said that, we don't feel comfortable with the timing of that. More importantly, we do not really consider the market in making our decisions, focusing more on a bottom-up stock picking process.
How do REITs fit into your strategy as a long-term, buy-and-hold investor?
Richardson: In making individual decisions on stocks, we look at the trade off between expected return and risk. With the 10-year Treasury yielding less than 4 percent and REITs yielding 7.5 percent, we believe they remain an attractive asset class with their risk being much less than other stocks.
However, the relative attractiveness of REITs has diminished in our minds relative to the small-cap universe that we focus on. In early 2000 we had more than 10 percent of our portfolio in equity REITs compared to 4 percent today. We do, however, have another 8 percent in REITs that would be considered mortgage or specialty REITs.
What is it about mortgage REITs that you find appealing?
Richardson: First of all, the yield is highly attractive, ranging from a low of 10 percent to a high of 18 percent. Two of the stocks, Annaly Mortgage and Anworth Mortgage Asset, have benefited greatly from
the very positive yield curve. Everyone knows that they will be under pressure when the curve flattens; however, they sell near book value with extremely high returns-on-equity. We have been net sellers over the last 12 months of these two REITs, having taken advantage of strong price appreciation.
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| *Equity and mortgage REIT holdings combined |
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| *Holdings as of Jan. 31, 2003 |
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The mortgage REITs have the following characteristics that we like: high yields, low p/e ratios, high levels of profitability, valuations near book value, well performing management and investor skepticism. If you believe Warren Buffett and expect stock returns to be between 5 percent and 10 percent going forward, than you don't need too many things to go right for mortgage REITs if you are starting with a current yield of 10 percent to 18 percent.
Which other segments of the
economy do you favor?
Richardson: The industries we currently like are consumer discretionary, energy, health care, selected financials and industrials. The key criteria that we focus on are return on invested capital and the relative valuation that we are paying for that. Historical earnings are important, along with balance sheet strength.
