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Amid the fallout of the 2000-02 bear market, one of the fund industry's biggest embarrassments was a slew of Internet funds launched just before the bubble burst. Big companies such as Merrill Lynch (MER, news, msgs) and Strong Mutual Funds and small shops such as Amerindo, Turner and Westcott launched funds that soon lost a lot of shareholders' money.
Nearly all of those mistakes have been swept under the rug -- that is, merged away or liquidated -- and many fund-company executives vowed never to repeat the debacle. They said they recognized that their greed for assets had blinded them to the need to do what's right for fund holders and that it's just plain wrong to launch a fund that you wouldn't touch.
Yet here we are, eight years later, and the fund industry has launched a truckload of real-estate funds on unsuspecting and/or greedy investors. All told, 37 real-estate funds have been launched this year, including those launched on the last day of 2006. The timing of those launches is downright atrocious.
Consider some of the returns: iShares FTSE NAREIT Mortgage (REM, news, msgs) has lost 40% since inception, Ultra Real-Estate ProShares (URE, news, msgs) is down 45%, and Cohen & Steers European Realty (EURAX, news, msgs) is off 27%.
Real-estate-investment trusts (REITs) enjoyed a tremendous run from 2000 through 2006, to the point where it was clear they couldn't continue their pace. And though real-estate funds typically buy commercial-real-estate securities, the mania in the housing market helped stoke investors' fervor for all things real estate. We saw rampant dot-com-style speculation in new homes, complete with two TV shows telling you how to flip a house. (Are they still on the air? If so, maybe they can tell people how to file for bankruptcy.)
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So, most in the fund industry had to know that this year was a bad year to dive into real estate even before "subprime" joined the national lexicon. Plenty of real-estate funds' managers were telling us last year that REITs had become pretty unattractive, and we were sounding cautionary notes.
In September 2006, Morningstar's John Coumarianos wrote: "Real estate is a good diversifier, but now's the time to trim, rather than add to, a position."
Even in 2005, Morningstar's Christine Benz urged readers not to speculate in real estate and pointed to past severe corrections in residential real estate. And Morningstar stock analyst Craig Woker wrote a piece titled "Real estate is the new dot-com: How to keep from getting burned in an overheated market." If we knew real estate was a bubble, you can be sure those launching funds knew it, too.
A fair number of the funds launched were global real-estate funds, and I'll cut some slack on that count, given that REITs are fairly new overseas and it hadn't gotten as crazy overseas as here. But it's still a trendy launch, and the losses at Cohen & Steers European Realty illustrate they have downside, too.
A new element in trendy fund launches is exchange-traded funds. They were still in their infancy for the dot-com boom, but they are in full swing today, and some can't resist any hot trend. XShares has seven new real-estate ETFs. (Editor's note: The article originally misidentified this fund company.) Barclays has six new real-estate iShares. The two companies are also at the forefront of carving out small niches in real estate that are reminiscent of the B2B (business-to-business) funds launched in 2000. Adelante appears to have sliced real-estate holdings by style so that there's growth, value and yield. Barclays did subindustries such as residential and retail.
What's missing in this is that fund directors, managers and executives aren't taking a step back to ponder their duty to fund holders. Should they launch something that they wouldn't touch? Are fund holders being served well when fund companies crank up marketing efforts after an extended run? Should we encourage investors to buy based on short-term performance?
If there's a silver lining here, it's that many of the largest fund companies refrained from encouraging bubble investing. American, Vanguard, Fidelity, T. Rowe Price, AllianceBernstein and Putnam are not on the list of those launching real-estate funds.
This article was reported and written by Russel Kinnel for Morningstar.
Updated Dec. 13, 2007
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