2023-04-04 03:58:04 ET
Summary
- KBWY's factor exposures are skewed towards small- and mid-cap US equity REITs, high dividend yields and struggling sectors such as office and retail.
- Major constituencies in KBWY's portfolio are heavily indebted and facing serious difficulties with access to sound financing.
- Investing in KBWY implies an opportunity cost, where other better capitalized US equity REITs offer similar level of yield.
- KBWY is not an optimal investment for investors, who expect above average current income with relative stability in the future.
The Invesco KBW Premium Yield Equity REIT ETF ( KBWY ) directs at least 90% of the AuM into small- and mid-cap US equity REITs with a focus on above-average dividend yields.
The exposure towards high dividend yields stems mainly from the underlying mathematics how the index's weights are determined. KBWY is a dividend yield weighted index, which allocates more to higher yielding stocks and less to lower yielding stocks relative to a more standard equity REIT benchmark such as Vanguard Real Estate ETF (NYSEARCA: VNQ ).
Since 2020, KBWY has significantly underperfomed VNQ - i.e., by ~23.5% on a total return basis. The key driver of the lagging returns was the combination of economic shutdown caused by the COVID-19 in early 2020 and the subsequent implications on the office and medical real estate segments. Since then, KBWY has not managed to recover, even if the juicy dividends are including in the calculations.
Now, the question is whether KBWY offers superior prospects for investors given the current dividend yield of ~8.5% and the existing discount relative broader REIT market.
In my opinion, KBWY is not an optimal choice. Below are three main reasons backing my opinion.
1. Suboptimal exposure
As mentioned earlier, KBWY is exposed to small- and mid-cap equity REITs with the bulk of holdings being classified more towards small-cap category.
Plus, there is a significant concentration in a relatively small sample of REITs. From the total 30 investments, many are struggling with both financing and structural headwinds.
Invesco Distributors, Inc
For instance, Office Properties Income Trust (NASDAQ: OPI ), Necessity Retail (NASDAQ: RTL ), Global Net Lease (NYSE: GNL ), all of which are Top 3 holdings, carry much higher debt loads on their balance sheets compared to the relevant sector average. Moreover, some of the holdings in the Top 10 are going through severe hardships in accessing sound financing. Gladstone Commercial (NASDAQ: GOOD ) and Medical Properties Trust (NYSE: MPW ) are examples of that.
Invesco Distributors, Inc
Four largest sector exposures in the KBWY's portfolio are office (21%), health care (18%), specialized REITs (16%), and retail (11%).
The long-term prospects of office and retail segments are weak considering the massive shift towards "work-from-home" and e-commerce. Several health care REITs are still struggling with recovery from the COVID-19 consequences and as a result have assumed a considerable amount of debt, which makes it more difficult to generate superior returns in the long-run. Both Sabra Health Care REIT (NASDAQ: SBRA ) and Omega Healthcare (NYSE: OHI ), which are one of the largest holdings in KBWY, carry heavier debt burden than on average in the industry.
In a nutshell, KBWY has huge allocations into the small cap REITs, which are relatively highly leveraged and struggling with fundamental trends that affect both short- and long-term performance.
To survive in the office REIT and brick and mortar retail space, a notable amount of new investments in redevelopment activities has not be made. Considering that KBWY's holdings are mostly of small capitalization and indebted, the likelihood of accessing cheap and sufficient capital is small.
The prevailing interest rate environment and problems in the banking sector make it even more difficult to attract optimal financing, especially for those REITs, which have class B or C assets based in secondary markets - which is often the case for small cap REITs.
2. Relatively unattractive yield
For the risks mentioned above, one would expect a truly high and attractive dividend yield. Looking back at the past 3 years, the current dividend yield seems not that appealing.
KBWY's portfolio constituents are high dividend paying companies with very aggressive FFO payout ratios. This means that there is a tiny amount of capital left at company level to invest in growth. Hence, the key return potential lies in the dividend yield, and not in the capital appreciation aspect.
Currently, VNQ yields roughly 4.2%, which implied a spread of ~430 basis points compared to KBWY. Plus, there are many REITs available in the market with strong balance sheets, solid growth prospects and large market capitalization levels that also provide attractive dividend yields. Simon Property Group's (NYSE: SPG ) and EPR Properties (NYSE: EPR ) are just some examples of these choices.
In the context of heavy risk exposures and other available alternatives offering similar yields at lower risk, KBWY's offer is not that attractive.
3. Time to be selective
In the times of uncertainty when the future trajectory of interest rates and overall economy is extremely ambiguous, it is the right moment to be a stock picker rather than just passive investor. This is especially true when the uncertainty is combined with relatively depressed valuations that we are facing at this moment among majority of the REITs.
The KBWY's case illustrates this perfectly, when in the portfolio there are many constituents, which entail an overly high degree of risk compared to the offered yields. As discussed above, investing in KBWY implies capturing juicy yield at a material opportunity cost. In other words, at KBWY's yield level there are other US equity REITs available with much more attractive risk and reward ratios.
In sum, KBWY is not an optimal investment for investors, who expect above average current income with relative stability in the future. Investment in KBWY boils down to capturing ~8.5% yield (which entail a high probability of being decreased) and going long small cap exposure in the segments, which face major challenges.
For further details see:
KBWY: Bad Choice During Times Of Distress