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A Unique Approach to REIT Investing Through a Risk Managed Framework
Guggenheim Risk Managed Real Estate Fund
Interview with: Thomas Youn

Author: Ticker Magazine
Last Update: Jul 14, 9:02 AM ET
Real Estate Investment Trusts, or REITs, may offer potential benefits to a broader portfolio including stock-like gains, bond-like yields, diversification and inflation protection. However, they may at times trade with elevated volatility. Thomas Youn, portfolio manager of the Guggenheim Risk Managed Real Estate Fund, explains how the fund takes a differentiated approach to investing in REITs that is designed to provide the many benefits of REIT exposure while seeking to mitigate volatility.


“The goal of the fund is to not only outperform the benchmark but to mitigate daily volatility and drawdown risk.”
Q: What is the history and goal of the fund?

A: The Guggenheim Risk Managed Real Estate Fund was launched in March 2014. Our portfolio combines Guggenheim’s traditional long-only domestic REIT strategy and its market neutral (long/short) REIT strategy.

The fund was designed to provide all the key benefits of REIT exposure including: high total return, attractive dividend yield, diversification, and inflation protection, while avoiding the downside of REIT exposure, which is volatility. We accomplish that by combining a long-only strategy with a long-short strategy and actively modulating the allocation between to two to manage the overall beta of the fund. The targeted allocation levels are determined by a proprietary REIT risk allocation model.

The goal of the fund is to not only outperform the benchmark but to mitigate daily volatility and drawdown risk on a risk-adjusted basis.

Q: How can REITs add value and diversify an investor’s portfolio?

A: Real estate is an interesting asset class in that it falls somewhere in between traditional fixed income and equities. The stream of rental income is typically contractual and bond-like in nature, while the potential for increasing cash flow is more similar to equities. Because REITs are not perfectly correlated with either stocks or bonds, they can be used to enhance the risk-adjusted return of a diversified portfolio.

Q: How is this fund different from its peers?

A: In three ways. First, this is the only REIT fund that combines a traditional long-only strategy with a market neutral (long/short) strategy combined with active beta modulation. This results in three potential drivers of excess return. The long-only sleeve can outperform the long-only benchmark, the long/short sleeve can generate an absolute return, while proper beta modulation can also contribute to excess returns.

Second, the risk mitigation objective is to not only outperform the benchmark over a full cycle but to reduce daily volatility by at least 10%. At the same time, we want to reduce maximum drawdowns by at least 25%.

Lastly, we have managed the underlying sleeves of this strategy since 2010 and have delivered consistent alpha and absolute returns. In fact, our long/short strategy has never had a losing year.

Over a full economic cycle, we would expect an average beta-to-index ratio of about 0.9. Based on our back test under the most extreme conditions, that could range anywhere from roughly 0.5 to about a 1.1.

Q: How do you manage volatility?

A: Historically, the volatility of the REIT sector was low relative to the S&P 500, but leading up to the financial crisis it was quite high. Today, it is not much different than the S&P 500 Index.

What we try to do is take advantage of the volatility by capturing most of the upside over a full cycle, but, at the same time, reduce our beta significantly when faced with adverse market conditions. It is not so much that our competitors are more volatile than the index, or that the index itself is significantly more volatile than the S&P 500; it is simply that the index has gotten more volatile post-financial crisis, and we are trying to mitigate some of that volatility.

Q: What guidelines drive your investment philosophy?

A: We start with the basic assumption that the REIT market is inefficient. Commercial real estate trades simultaneously on two different markets: the private market and the listed REIT market. Since the underlying assets in both markets are the same, over the long run they are tied at the hip; however, in the short run there are often substantial divergences.

By comparing fundamental trends between the markets, we look for value opportunities. As a real estate specialist, we use net asset value as our primary metric for gauging the valuation, as opposed to earnings multiples or dividend yield.

Q: How would a potential rise in interest rates affect REITs?

A: History has shown that there is no consistent correlation between REIT performance and interest rate tightening cycles. During the last cycle, REITs performed exceptionally well, while during the current tightening cycle, REITs have posted modestly positive gains. In some of the earlier cycles REITs underperformed.

Normally, rising interest rates reflect improving economic fundamentals, which is accompanied by increasing economic activity, higher occupancy rates, and rising rents. There may be other times or situations, however, when interest rates are rising, but economic growth and rents aren’t rising commensurately. We make every effort to understanding what is happening at the macro level, but we are really focused on trends that impact our specific industry.

A current example would be what is happening in the retail REIT sector as online shopping has become more popular. We have been underweight retail REITs, particularly the big-box shopping center REITs, as well as lower quality regional mall REITs. At the same time, we have favored industrial and distribution real estate REITs that will benefit from the impacts of the online shopping.

Q: What is your investment process?

A: We follow a top-down portfolio construction process with bottom-up stock selection. Using a specialized relative value framework specific to the REIT space, we estimate the net asset value of each REIT.

We then estimate the warranted premium or discount at which each REIT should trade at relative to its fair market value. The estimate combines a number of subjective as well as objective factors. Factors like balance sheet leverage, corporate governance, management track record and acumen all have an impact at where a REIT trades relative to its net asset value.

We conduct fundamental research on major property markets, meet with local property brokers, and meet with management teams to formulate a view on the local economies and real estate conditions. Those assessments help us shape our top-down sector allocation.

We then identify stocks that are consistent with our top-down views and appear attractive from a relative value basis. Since inception, roughly two-thirds of our alpha has been generated through stock selection and the balance through sector allocation.

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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc