Everyone is abuzz about inflation! And why not? With out-of-control fiscal spending and perpetual easy money from the Fed it seems like hyperinflation is the only possible result. However, aside from the “transitory” blips in inflation that we have seen as we emerge from the depths of the global pandemic, we have not seen anything that appears to be long-lasting.
So, whether we see inflation or not, we must be diversified to protect ourselves from it since a decline in purchasing power over time is a certain way to ruin a retirement! One of the ways to hedge your inflation risk is to own assets that are positively correlated with inflation. Academic studies continue to show that equities, including the real estate asset class structured as real estate investment trusts (REITs), are a good hedge against inflation.
The simplest way to get exposure to the REIT asset class is through the exchange-traded fund (ETF) vehicle. There are many low-cost, passively-managed REIT ETFs that have provided relatively high income, strong historical returns, and low correlation/good diversification to other equity types. The top five REIT ETFs by assets under management are Vanguard Real Estate Index (VNQ, $40.1B), Schwab U.S. REIT (SCHH, $5.8B), iShares U.S. Real Estate (IYR, $4.8B), Real Estate Select Sector SPDR (XLRE, $3.0B), and iShares Core U.S. REIT (USRT, $2.0B).
As seen from the chart below, so far in 2021 investment performance has been very good with them all clustered towards the top of the performance chart with 20%+ returns easily outpacing the S&P 500 (IVV, the green line at the bottom) after lagging last year with pandemic-induced negative returns. No one knows if real estate will be forever damaged from the pandemic, but performance so far this year does offer some comfort.
Being passively-managed, the REIT ETFs all follow a published index and strive to replicate the index performance, less the management fee. The ETF sponsors all use indices from the major index providers like MSCI, FTSE, and Dow Jones/S&P. Interestingly, the indices all look relatively similar with the main differences being the level of diversification, the individual REIT weighting approach, and number of holdings.
For example, the Vanguard ETF (VNQ), the largest at $40.1 billion, restricts the sum of the weights of all issuers representing more than 5% of the fund to not exceed 50% of the fund’s total assets whereas the Schwab ETF (SCHH) restricts the sum of the weights of all issuers representing more than 4.5% of the fund to not exceed 22.5% of the fund’s total assets; quite a difference in approach with neither one necessarily being better or worse. No one knows in advance which indexing approach will be the top performer over any market cycle, so best to select one and stick with it.
All these ETFs are low-cost with investment management fees less than 12 basis points (0.12%), except IYR that is at 42 basis points (0.42%).
There are other asset classes that also provide a good inflation hedge including gold, commodities, and other common stocks, but none of those provides the extra benefit of the REIT asset class with relatively high cash income that can be used to pay living expenses in retirement or reinvest/rebalance into the fund over time.