The S&P 500 just welcomed its newest real estate investment trust to the index, urban office specialist REIT Alexandria Real Estate Equities Inc (NYSE:ARE). ARE stock specializes in office space for technology and life sciences companies in innovation clusters like Boston, San Francisco, New York and Seattle.
ARE is not a particularly high yielder by REIT standards, yielding a modest 3% at current prices. But the REIT has been aggressively raising its dividend, more than doubling it since 2010.
To make room for Alexandria Real Estate, Standard & Poor’s is giving beleaguered solar energy company First Solar, Inc. (NASDAQ:FSLR) the boot, relegating it to the S&P Midcap 400 index. Likewise, Advanced Micro Devices, Inc. (NASDAQ:AMD) and Raymond James Financial, Inc. (NYSE:RJF) are getting promoted to the S&P 500, while Urban Outfitters, Inc. (NASDAQ:URBN) and Frontier Communications Corp (NASDAQ:FTR) are getting demoted to the S&P Midcap 400.
The move was part of a larger index reshuffle that resulted from S&P’s changing its market cap criteria. To make the cut for the S&P 500, a company now needs to have a market cap of $6.1 billion or greater, up from $5.3 billion previously.
Changes like these aren’t rare, as S&P adds and subtracts at least a handful of companies every year. But there are some points worth noting.
Expect to See More REITS in the S&P 500
REITs have been eligible for the S&P 500 since 2001, when Equity Office Properties broke into the index as its first REIT (Equity Office has since merged with Blackstone Group LP (NYSE:BX)). The list has now ballooned to 29 names, and I expect that number to continue growing.
S&P carved out a dedicated sector to REITs last year, whereas previously they had been lumped into the financial sector. This higher profile should only accelerate the flow of capital into the REIT sector, boosting market caps and making more REITs eligible for inclusion in the S&P 500.
This goes hand in hand with the broader acceptance of REITs among investors. In the 1990s, when I first started investing, most investors had never heard of them, or if they had, they didn’t understand them or had a negative opinion of them. 20 years later, REITs are viewed by many investors as a mainstay in an income portfolio. And I don’t see that changing.
While rising, CD and bond yields are still exceptionally low, and investors looking to secure a respectable income from their investments will need to look beyond traditional fixed income. The global hunt for yield is far from over.
Solar is Dead for the Foreseeable Future
I have no doubt that solar energy will play a big part in America’s future, and for that matter, the world’s future. Of all renewable energy sources, solar creates the fewest environmental side effects.
But until battery storage gets better and costs fall, solar simply isn’t going to grow without massive federal subsidies, and the political winds have shifted on that front. First Solar being dumped from the S&P 500 is a subtle reminder of this.
Your Passive Index Fund Really Isn’t Passive
And finally, it’s worth noting that the distinction between “active” funds and “passive” index funds isn’t quite cut and dry. While index funds have substantially lower fees than most active funds and do, in fact, passively follow an index, the index itself is actively managed.
As I noted earlier, Standard & Poor’s is constantly changing the mix of its indices. On average, 25-30 stocks are replaced each year from the S&P 500, which is more than 5% of the index. Some of this is due to mergers, bankruptcies or some disqualifying event, such as a drop in market cap. But the Index Committee also has a fair amount of discretion about what companies get added and which get dropped.
Over time, the turnover can be significant. Since 1999, more than half of the companies in the index have been replaced.
So, while indexing is a fine strategy for a lot of buy-and-hold investors, you shouldn’t get dogmatic or even superstitious about the wisdom of the market. The S&P 500 has managers, just like any active mutual fund. They just trade a lot less, allowing index funds to keep fees lower.
So, keep an open mind on “smart beta” strategies that attempt to build a better index mousetrap. There is nothing mystical about what S&P does with its indexes.
As of this writing, Charles Sizemore was long BX stock.