Monday, June 11, 2012

Private REITs

A fairly new (to me) blog that I've been following is by Josh Brown, aka "the reformed broker".   Josh has a great post on private REITs.   For those who don't know, a REIT is a "Real Estate Investment Trust".  These are basically companies that only invest in commercial real estate and Josh doesn't like them.  He invokes his 4 rules.
1. Brown's Law of Brokerage Product Compensation states that the more money a broker or financial salesperson is paid to sell you something, the worse it is for you.  The commissions on non-traded REITs are in the range of 7% versus the $5 trade you could do to buy a public REIT. 
2. Opacity is always indicative of information assymetry, and information assymetry always benefits The Street, not the clientele.
3. High-fee funds or vehicles will never match the underlying index by definition - the fees act as a drag in bull markets and add insult to injury in bear markets.
4.  The only self-justification brokers ever had in recommending private REITs was that because they don't trade and reprice publicly each day, they somehow served to "smooth the volatility" of a client's portfolio.  Which is Bullshit to the second power (BS²).
It won't come as any surprise that I completely agree with him.   In particular, I think that #4 often gets ignored, even by well informed institutional investors.  For example, it is not at all uncommon to see Private Equity investments in pension funds and college endowments for the alleged purpose of reducing volatility.  Private Equity reduces volatility because it is only valued periodically, and the valuation is done by the manager of the fund.  It's like saying your cholesterol is stable because you only get it checked every 5 years.   Just because something has a low recorded volatility doesn't mean that it is actually reducing the risk of your fund, all that is happening is that the risk is being ignored because it can't be measured.