The protesters occupying Wall Street and locations in many other cities have strong cases to make against the privileged people in power. It's easy to find fault with the rich and wealthy institutions, and in many ways it's reasonable to feel that the deck is stacked against us. But sometimes we individuals can do better than the rich. The folks at Morningstar recently offered evidence of that, via a study of real estate investment trusts.
In a study commissioned by NAREIT that looked at 20 years of data, Morningstar found that publicly traded stock REITs performed considerably better than private equity real estate funds. They also tend to sport lower fees and use less leverage.
The private equity scoop
Here's an explanation of private equity funds from one of the horses' mouths, Swiss financial giant UBS (NYSE: UBS ) : "pools of actively managed capital that invest in public and private companies with the intent of creating value in the companies in which they invest by improving operations, reducing costs, selling non-core assets and maximizing cash flow. ... These funds generally seek returns superior to public equity markets through the purchase, creation of value and sale of a portfolio of companies."
Notice that goal: to achieve returns superior to the stock market. Well, according to this new study, lots of private funds are failing in that mission.
Other studies find all kinds of fancy investments to be delivering underwhelming performances. A 2008 report from the Maryland Tax Education Foundation found that "leveraged buyout funds and venture capital funds provide less investment return than a portfolio of public stocks duplicating the S&P 500 index." It also mentioned another study concluding that the average hedge fund underperforms the public markets.
Fees, fees, fees
What's the problem with these investments? Well, in many cases it all comes down to fees. Money managers aren't getting rich by letting investors keep all of their gains.
According to a 2007 study, private equity funds actually outperformed the S&P 500 annually by about 3 percentage points -- on a pre-fee basis. But once you factor in fees, they underperformed it by 3 percentage points per year! That kind of difference can really add up.
Hedge fund managers often take around 2% of investors' money as an annual fee, and then take 20% of the fund's profits as well.
It's enough to (almost) make you feel bad for those rich folks and institutions (such as pension plans) that are parking money in private funds when they could opt for the regular stock market like the rest of us. (A sad little irony is that many of us do have some money in private equity funds, via the investments of pension plans.)
Opt for the common market
Whether you're after investments in real estate or other businesses, the stock market can serve you well. Buy into a common stock or REIT and you'll only pay a commission to your brokerage, which can be quite small indeed. (Our Broker Center features some good-quality, low-cost brokerages.) You won't be charged any annual fee.
If you'd rather not have to pick individual companies on your own, consider handy exchange-traded funds, which offer you baskets of securities that look like mutual funds but trade like stocks. You can apparently beat many or most private equity funds simply with a broad-market ETF such as the SPDR S&P 500 ETF (NYSE: SPY ) or the Vanguard Total Stock Market (NYSE: VTI ) .
Moving into individual companies, consider REITs such as Annaly Capital Management (NYSE: NLY ) and Chimera Investment (NYSE: CIM ) , which specialize in real estate investments made with borrowed money. As long as interest rates stay low, the wind may stay at their back, and they've been offering huge dividend yields north of 15% recently. There are plenty of other candidates, such as Health Care REIT (NYSE: HCN ) , which focuses on (you guessed it) medical properties and residential health-care facilities.
To diversify your money across many REITs and reduce the risk of getting whacked by any single stock, you might look into an REIT ETF such as the Vanguard REIT Index ETF (NYSE: VNQ ) . Remember those hefty private equity fund fees? Well, Vanguard is known for low fees, among other admirable traits -- its REIT ETF will cost you just 0.12% per year.
The upper crust of society may have bigger homes and more expensive cars than we do, but they don't necessarily have an advantage when it comes to where they can invest their money. Terrific investing opportunities abound if you just keep your eyes open.
Want some great stock ideas? Help yourself to a free copy of our brand-new report: "Secure Your Future with 11 Rock-Solid Dividend Stocks."
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