A reboot of the S&P 500 index group weights has arrived as Real Estate Investment Trusts (REITs), which have long been a part of the pre-existing financial industry group, has been classified as an independent industry group on its own to increase the total industry groups within the S&P 500 from 10 to 11. This new sector will have two subcategories, Equity REITs and Real Estate Management & Development companies. Mortgage REITs, however, will still remain a part of the financial sector.

Index supervisors are remolding the financial  sector into two by separating the real estate investment trusts from brokerage firms and banks, and giving each a different niche in the S&P 500. As such we expect this sector to have more asset flows into it over time and preview certain ETFs in the Real Estate space that would benefit investors:

  • VNQ – Vanguard REIT Index Fund
  • IYR – iShares U.S. Real Estate ETF
  • SCHH – Schwab U.S. REIT ETF
  • RWR – SPDR Dow Jones REIT ETF

iyr

IYR, an iShares product, seeks to track the investment results of an index composed of U.S. equities in the real estate sector. It has returned approximately 10% annually since inception, has a 30 day SEC yield of  3.23% and an expense ratio of 0.44%.

Reverting back to the new classification change, much as this does not appear to change the inherent value of underlying assets, these steps are important to investors especially those who own exchange traded funds that track financial organizations. However, given Real Estate is going to have its own sector, Equity REITs should receive more attention from investors. Longer term, we expect a more diversified group of owners along with  increased liquidity. The decoupling from the Financial Sector will possibly result in lower volatility for this asset class over market cycles.

The motivation behind this reordering and new introduction is a bit eccentric. At the moment, the S&P 500 which is the yardstick for American equity contains 10 industry categories such as utilities, financials, and technology. According to the Head of State Street’s ETF and mutual fund research, David Mazza, the goal was to decouple REITs from financials given the highly sensitive interest rate nature of this asset class relative to financials.

The financial industry sector of the S&P 500 contains a subset of 28 REITs whose stocks are at the moment doing way better in market value than other big players such as mining and telecommunication sectors. Previously, REITs have been considered as alternative investments and the traditional financial representation and selection have made it hard for a regular investor to determine the value of these companies. As investors are becoming more knowledgeable and sophisticated, they are also making products such as REIT ETFs more popular.

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