Sky High

Funds focusing on real estate rose 13 percent from April through June, making them the best performers of those that invest in industry sectors.

Mutual Funds: Second-quarter Maryland Report

July 17, 2005|By Laura Smitherman | Laura Smitherman,SUN STAFF

Call it the Goldilocks economy. It wasn't too hot in the second quarter of 2005, as the Federal Reserve continued to raise short-term interest rates and inflation fears abated. It wasn't too cold, as consumer spending and corporate profits increased at a slowing but steady pace. And yes, it was just right for someone in particular: the real estate fund investor.

Mutual funds that invest in real estate companies, which buy up office buildings, apartment complexes and shopping malls, rose 13 percent from April through June and ranked as the best performer among those that invest in industry sectors. Apart from three down months, including two in the first quarter, the funds have gained over the last two years as commercial real estate has boomed along with home prices.

Real estate helped pull investors out of negative territory from the first quarter to an average 2.3 percent gain for stock funds and an average 1.8 percent gain for bond funds, according to Lipper Inc., a fund-tracking firm in New York.

Most of the 228 Maryland mutual funds surveyed by Bloomberg News posted positive returns -- some in the double digits. Analysts said it was a stock picker's market, with certain sectors emerging as clear standouts. In addition to real estate, funds that invested in utilities, energy, telecom, biotech and health care also did well. Industries that are fuel-dependent, such as airlines, suffered as oil prices climbed to an all-time high of more than $60 a barrel.

"Real estate was kind of the star of the quarter. We've been in a long-running boom for real estate, and it just keeps going," said Russ Kinnel, director of fund research at Morningstar Inc. "Other than that, you had moderate returns. Stocks went up and did OK. Bonds generally had a pretty decent but quiet time."

Investors might have missed the somewhat rosy economic picture in the second quarter as they largely erased losses from the first quarter, and as a number of factors weighed on the market, including rising oil costs and talk of a housing bubble. The Standard & Poor's 500 index ended the second quarter at roughly the same spot that it began the year.

But a stream of positive economic data emerged in recent months. A half-million jobs were added in April, May and June, and at the end of last month the Commerce Department reported the economy grew a higher-than-expected 3.8 percent during the first part of 2005. Corporate profits in the second quarter, to be reported in the next few weeks, are expected to have risen as much as 10 percent, and wage gains helped keep consumer spending robust.

"Everyone is worried about a lot of things, and terrorism keeps cropping up, and people may have lost sight of the fact that the economy is doing a nice job," said Bill Dwyer, chief investment officer at M&T Bank Corp.'s investment advisory subsidiary, based in Baltimore.

Still, the overall stock market is likely to remain choppy, and investors need to pick and choose their spots, said David C. Reilly, director of portfolio strategy at Rydex Investments, a mutual fund company in Rockville. "You can make money, but it's not going to be by buying an S&P Index fund and holding it," he said.

One place investors have increasingly turned is real estate. Six of the top 10 performers among Maryland mutual funds focus on those stocks, including ProFunds Real Estate UltraSector Fund and T. Rowe Price's Real Estate Fund, which had a 20 percent return and a 14 percent return, respectively.

ProFunds provides leveraged exposure to the Dow Jones real estate index. It counts Simon Property Group Inc., the largest owner of shopping malls in the United States, as one of its biggest holdings. Among Price's top holdings is AMB Property Corp., which owns and builds industrial properties.

Behind the commercial real estate craze is a phenomenon that has come to be known as Alan Greenspan's "conundrum." Greenspan, longtime Fed chairman, has been raising short-term interest rates, which typically portends higher mortgage and long-term bond rates that are determined by the markets.

But that hasn't been the case. Mortgage rates have fallen for most of this year, and the benchmark 10-year Treasury note fell about one-half of 1 percent in the last three months -- one factor that boosted mutual funds in bonds.

The lower rates also kept down borrowing costs for real estate firms. David M. Lee, portfolio manager for Price's real estate fund, said investors have been drawn to the sector not only because it has gained but also because it provides portfolio diversification and dividends. Real estate investment trusts are required by law to distribute 90 percent of their taxable income to shareholders.

As for the conundrum, Lee said, "If Alan Greenspan is confused by the situation, I doubt I would be able to shed any light on it."

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