Afternoon Review

Principal Financial Group (PFG) -11.31%
Principal moved lower amid concerns that losses on fixed-income investments will deplete capital. Life insurers are facing an increase in defaults on corporate bonds and commercial mortgages as the U.S. recession depends. The carriers cut jobs, asked regulators to ease reserve standards and applied for government aid in the fourth quarter to replenish their dwindling capital cushion.

The biggest risk, at this point, is a new wave of credit defaults that would undermine these companies’ capital adequacy.


Caterpillar (CAT) –4.95%
Caterpillar fell on speculation that the government stimulus spending plans may not give the company a boost. In addition, a Morgan Stanley report said the company faces a “steep fall” in sales from emerging markets. Bets against shares of Caterpillar reached their highest level since April.



REITs
Our REIT holdings (VNQ, ICF, IYR) all fell more than five percent today and are down over 15 percent YTD. After three quarters on flat returns in 2008, our REIT holdings fell between 38 and 40 percent in the final quarter.

The biggest concern surrounding REITs is liquidity. REITs carry high debt levels and most will need to repay or refinance obligations in the year ahead. Securing capital at attractive terms should remain challenging, which will squeeze companies with large development pipelines that rely on banks to provide funds for construction.

It is likely that several REITs will need to issue new equity or reduce dividend payments to improve liquidity. While this may provide some relief, it hurts investors’ confidence and further reduces share prices.

The main reason Acropolis invests in REITs is because of their relatively low correlation with the stock market, and thus it diversifies away from some of the risk inherent in the stock market. Rather than investing in individual REIT companies, we use the following ETFs to get diversified real estate exposure:

VNQ (Vanguard REIT ETF) boasts a relatively broad-based domestic portfolio, making it a suitable choice for one-stop, no fuss real estate exposure. The biggest risk the fund carries is that more than 40% of assets are in its top ten positions. If one or more of these names falter, the fund’s performance will suffer. VNQ carries a 0.12 expense ratio, which ranks as the cheapest real estate ETF on the market.

ICF (iShares Cohen & Steers Realty Majors Index Fund) has solid exposure to the biggest, best-managed public landlords of the major property types – office, retail, industrial and multifamily. ICF carries a 0.35% expense ratio, which is cheaper than most, but not all REIT mutual funds and ETFs.

IYR (iShares Dow Jones U.S. Real Estate Index Fund) has exposure to the largest biggest, best-managed public landlords of the major property types – office, retail, industrial and multifamily – as well as some more exotic corners of the REIT world like timber and brokers. IYR carries a 0.48% expense ratio, which is cheaper than most, but not all REIT mutual funds and ETFs.



Quick Hits

• Economic Stimulus Package May Reach $850 Billion
• Greenhouse-Gas Limits Proposed by Industry Would Raise Coal Plant Costs
  
  
  

Peter Lazaroff, Junior Analyst