Co-CIO Francis Gannon details what investors need to know about Real Estate, the newest GICS sector.

Real Estate

There’s a new sector in town—Real Estate. (You may have already noticed the new sector mentioned in our recent small-cap market performance discussions.)

Real Estate was added to acknowledge “the growing importance of real estate in the world’s equity markets” and to reflect “the position of real estate as a distinct asset class and a foundational building block of a modern portfolio, rather than an alternative,” according to S&P Dow Jones and MSCI.

The new sector consists of two industry groups that formerly resided in the Financials sector—equity REITs and real estate management & development companies. Mortgage REITs remain within Financials.

[drizzle]We applaud the move. Most real estate companies have business structures that differ markedly from financial companies and show different long-term performance patterns as well, which we think will be seen more clearly now that Real Estate has a home of its own.

The change, which S&P Dow Jones Indices and MSCI Inc. first announced in March of this year, became effective with the close of business on August 31st. This marks the first change to the GICS—the Global Industry Classification Standard—since its inception in 1999.

What The Change Means for The Royce Funds

As for any potential effect on Royce portfolios, a few items are worth keeping in mind. First, we base our investment decisions on our view of a stock’s intrinsic attractiveness and not its external sector classification. So these shifts in and of themselves will not affect how we invest.

Some Royce portfolios have owned REITs at times over the years, but neither equity nor mortgage REITs have ever been an area of primary investment focus. While both types often sport attractive high yields, they also usually lack the combination of balance-sheet strength and a long-term history of above-average profitability that we seek in most of our portfolios.

We will continue to look at REITs selectively in the same opportunistic way that we always have.

We remain interested in the real estate management & development industry because many companies in this industry do fit our investment criteria. We have historically been able to find several attractively valued companies (based on our analysis of their current worth) in the industry—those with some combination of low leverage, strong management, and the potential for strong growth.

This will not change.

By The Royce Funds

 

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