Defining An Asset Class
Mladina’s findings are consistent with those of my colleague, Jared Kizer, chief investment officer for Buckingham Strategic Wealth and The BAM Alliance, and Sean Grover in their May 2017 paper, “Are REITs a Distinct Asset Class?”
Their research was motivated by the observation that many studies treat REITs as a distinct asset class based on correlation alone, and that many investors overweight REITs in their portfolios on a market capitalization basis. Their data sample covered the period January 1978 through September 2016.
In their analysis, Kizer and Grover employed a six-factor model comprising the market, size, value and momentum equity factors as well as the term and credit fixed-income factors. The credit factor (referred to as IGDEF) subtracts the return of a duration-matched portfolio of Treasuries from the corporate bond index total return.
Following is a summary of their findings:
- The annual alpha estimate for REITs was -0.89% with a t-stat near zero (-0.3).
- REITs showed statistically significant exposure to market beta (0.61 with a t-stat of 10.2), size (0.44 with a t-stat of 6.1) and value (0.77 with a t-stat of 9.9), as well as a small negative (-0.08) and statistically insignificant (t-stat of -1.7) exposure to the momentum factor, a large (0.70) and statistically significant (t-stat of 3.8) exposure to the term premium, and a large (0.92) and statistically significant (t-stat of 3.9) exposure to the credit (default) premium.
- While the r-squared value was relatively low for REITs (0.51), this was also true for other industries they examined, including energy, utilities and health care.
These findings led Kizer and Grover to conclude: “While the relatively low correlation with the S&P 500 Index and 5YT was encouraging, the four- and six-factor regression models indicate that REITs are likely not a distinct asset class, especially when compared to the results of other industries.”
Kizer and Grover next tested whether REITs could be easily replicated by a long-only portfolio of established asset classes. Given the factor exposures they found, and using returns for U.S. small-cap value stocks (SV) from Ken French’s data library and the Barclays long-term corporate bond index (CORP), they attempted to replicate REIT returns with these two returns series.