If you want a unique flavor for an exchange-traded fund (ETF), then you should check out the offerings from IndexIQ. The company’s mission is to bring alternative investments to the masses, with options like hedge fund plays.
I recently had a chance to interview IndexIQ’s CEO, Adam Patti. Adam has an interesting background: Before launching IndexIQ, he built a venture-backed supply-chain software company (ThreadeXchange) and was even an Associate Publisher at Time Warner (TWX) Subsidiary Time Inc., overseeing properties like Fortune, Money and CNNMoney.com.
In my interview with Adam, I focused on his IQ US Real Estate Small Cap ETF (ROOF). For the most part, it had a good year in 2013, with a return of 15%.
Here’s what he had to say:
Q: Looking back at the past year, what are the takeaways for ROOF?
A: We outperformed our large-cap REIT peers by about 10 percentage points. But the portfolio is still attractive, when you look at price-to-earnings ratios and cash flow multiples. Also, we were better in terms of the yield, which was 7.25%. It was about 300% higher than the alternatives. Moreover, ROOF’s volatility was similar to the large caps and the maximum draw down in 2013 was less than the largest REIT ETF.
Q: Why the outperformance?
A: Large-cap REIT funds are usually concentrated. Many of the stocks have diverse operations, so adding one more stock does not add much to the portfolio. But volatility can also be high. We saw this when interest rates spiked. Many advisors and retail investors are buying the same large-cap securities and the ETFs that hold them. In other words, large amounts of money can move in and out of these ETFs. This increases volatility, extends valuations, and reduces the dividend yields.
Q: What about the timing for real estate in 2014?
A: It’s a good time to enter the market. Rising interest rates may have some impact. But this should not be a problem if growth in the economy gets better. And there are signs of this. But you still need to pick the right spots, which is easier with a small cap focus. Even if growth does not come, interest rates will back down and this will make REIT yields look more attractive.
Q: What scenario could hurt a fund like ROOF?
A: Well [...] if growth falls and interest rates increase — in such a scenario, you could actually see cuts in dividends. This may sound contradictory, but it has happened before, such as in the 1970s. But we do not think this is in the cards for the U.S. economy right now.
Q: For a regular investor, what do you recommend for exposure to real estate?
A: Of course, it depends on a person’s personal situation. For example, you need to account for the ownership in your house or other properties. But in general, an asset allocation of 5% to 10% is reasonable. It’s also important to note that real estate can be a hedge against inflation. The values of the assets increase but so do the rents, which means higher dividend payouts. People always need a place to live.
Q: What about other interesting products from your firm?
A: One that has been popular is our M&A ETF (MNA). It’s true that it seems that analysts have been predicting a spike in deal-making for many years. And it has not happened, even though companies are sitting on huge amounts of cash. But if growth improves in the U.S. economy, then M&A should do so as well. As for our MNA fund, it takes a low-risk approach to playing this. This type of investment can be a good place for investors who are looking for something to do with their fixed-income dollars because as rates rise, fixed income prices fall and investors struggle to find a place to invest with a similar volatility profile. MNA could be a valuable and effective option given its historical performance profile.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.