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But what to put on your watchlist? In the latest entry in our ongoing series, Fool analyst Ilan Moscovitz shares three real estate investment trusts he's been watching.
Two to watch
Generally speaking, Ilan is a fan of REITs today. They historically have had low correlation to other asset classes, moving in different directions than bonds and other types of stocks. That means that these investments potentially offer a way to capitalize on the economic downturn. REITs have made money in five of the nine years that the S&P 500 posted a negative return since 1972. Though that trend didn't stick during the recent recession, over the past decade, the Vanguard REIT Index fund posted an average annual return of 10.4%, compared with an average annual loss of 1% for the S&P 500, according to the Fool's Rule Your Retirement newsletter service. And the fact that REITs don't pay taxes as long as they distribute at least 90% of their income as dividends is an attractive benefit.
The first REIT Ilan looked at was Anworth Mortgage Asset (NYSE: ANH ) , which boasts a 13.4% dividend yield. As he explained, the model of firms like Anworth is: Imagine if you could borrow $10,000 at 2%, lend it at 4%, and keep the $200 difference. That's the business in a nutshell. Companies in this space issue shares to raise capital, which they lever up with short-term financing. They use this capital to buy longer-term mortgage-backed securities, collect the interest on these securities or sell them, and then repay its lenders. Anworth relies more on variable rates, which tend to perform better in a rising interest rate market. To Ilan, that makes it worth watching, but not buying.
The same was true for Chimera Investment (NYSE: CIM ) , although for different reasons. Chimera earns a hefty 17.9% yield by peddling in riskier areas, non-agency mortgage-backed securities that don't come with government guarantees. It has a lot less leverage in order to make up for that, but the added default risk in its portfolio knocks it down a notch in Ilan's eyes.
And one he bought
But nearby, Ilan found a REIT on his watchlist that he felt was the best bet as the first purchase in his Rising Stars portfolio. Annaly Capital Management (NYSE: NLY ) manages Chimera, but it runs a far more vanilla portfolio (vanilla being a good thing). With a long track record of success, a strong management team, and a portfolio that makes Ilan far more comfortable than other players, Annaly is poised to thrive in today's market environment.
"And it's one that's likely to persist for some time," he w rote. "As it's exceedingly unlikely we're going to see any meaningful economic stimulus to address unemployment emerge from the soon-to-be Republican-controlled House of Representatives and dysfunctional Senate, we can expect the slump -- and low interest rates -- to continue for some time. Traditional monetary rules prescribe as many as four years (!) of near-zero percent interest rates to cope even with mainstream economic forecasts." Based on that, Annaly made the jump from Ilan's watchlist to his portfolio, where it will reward him with a hefty yield -- currently above 15%.
And that's exactly why it pays to watch. You can make smarter investing decisions with your own version of My Watchlist, new and free from the Fool. Click below to start following one of the stocks mentioned above: