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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.


ďThe goal of the fund is to not only outperform the benchmark but to mitigate daily volatility and drawdown risk.Ē
Q: Can you give a specific example to describe your investment process?

A: One recent trade that we put on was an investment in a prison REIT. There are two leading prison REITs, CoreCivic Inc. and GEO Group Inc. They both fell about 60% between July and October 2016. That was caused by panic due to the Federal Bureau of Prisons issuing a statement saying that they were planning to reduce private prison populations.

The valuations of these REITs dropped from 13 times down to 7 times EBITDA in less than six months. But when we analyzed the impact of what was announced, the impact on earnings was likely to be about 10% spread over a number of years.

After looking more closely at their current contracts, we realized that, even if 10% of their cash flow were to be removed, they were way undervalued. With meeting with their management teams and sell-side analysts, we took a position that turned out to be our best trade last year. While that is an extreme example, it illustrates how doing fundamental due diligence and seeking attractive relative value, can pay off.

Q: Do you set price targets for making sell decisions?

A: No, we donít set price targets because we donít focus on absolute valuations. We closely monitor relative values. It is only when the relative value gap closes sufficiently that we consider taking off a winning position.

Q: Do you only participate in the publicly-traded REITs?

A: We invest primarily in domestic publicly-traded REITs but also invest in real estate C-corporations and other real estate related areas. Mortgage REITs, for example, are also within our investable universe, though we are less active in that sector. The majority of capital is typically invested in the traditional commercial REITs: apartments, shopping malls, office buildings, etc.

Q: What is your portfolio construction process?

A: Our investable universe is broader than the REIT Index, but remains focused on real estate. Our benchmark index contains roughly 150 to 160 REITs which includes a broad cross section of property types. We also include companies that may not be REITs for tax purposes, likewise own, build, or manage real estate such as homebuilders, hotel operators, and real estate service providers that are not included in the benchmark.

Diversification is an important part of our process. Our long-only strategy typically has 50 to 60 positions, while our long/short strategy has 55 to 75 positions. For each strategy, we have investment guidelines that allow us to generate alpha, but at the same time, limit the impact of a single mistaken position or from some other unforeseen event.

The risk-managed fund is a combination of the two-individually managed, independent portfolios. The long-only portfolio has sector overweight or underweight limits of about 300 basis points and a maximum cash balance of about 5%. In addition, we limit any single position to 15%.

The largest REIT index constituent is roughly 10%, so that is roughly a 500-basis point overweight for an individual position. But we are typically targeting tracking error of about 200 basis points versus the index.

The long/short strategy uses a different methodology altogether. It is market neutral at all times with no directional bias. We normally target an annualized standard deviation between 3% and 5%, so it is a very low risk and low volatility strategy.

In that portfolio, we would typically have 30 to 40 long positions and 25 to 35 short positions. The maximum size of a position could represent 10% of the portfolio, although more commonly each position would be no more than 4%. No sector would represent more than 25% of the gross exposure. On a net basis, no one sector can be net long or net short greater than 10% of the portfolio.

Q: How do you define and control risk?

A: From a broad perspective, we view risk in terms of our tracking error versus the benchmark. We control risk by carefully monitoring our portfolios to be sure that they adhere to their respective portfolio construction guidelines. We also monitor for any outsized style or factor biases.

In addition to the real estate teamís risk management framework, the firm has broader risk management teams and frameworks monitoring our portfolios at a higher level. Within the equity group, for instance, we hold monthly performance review meetings where risk and performance analyst look at the risk parameters for our strategies to verify that we are maintaining risk within our guidelines.

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