Fidelity MSCI Real Estate Index ETF (FREL) invests in U.S. real estate stocks. The fund seeks to track the investment results of the MSCI USA IMI Real Estate Index. The fund currently has over 160 stocks in its portfolio. The fund has high exposure to strong growth sub-sectors such as specialized REITs (e.g. datacenters, communications towers, etc.) and industrial REITs that will benefit from several important secular trends in the next few years. It also has low exposure to cyclical sub-sectors such as retail, office, and hotel REITs. Although the recovery of the real estate industry may take a while unless a vaccine is proven to be effective, the current low rate environment should be supportive of FREL’s valuation. Investors of FREL will also earn a 3.7%-yielding dividend. Therefore, this is a good fund to own especially for investors with a long-term investment horizon seeking both income and capital appreciation.
Data by YCharts
FREL has high exposure to specialized and industrial REITs
FREL has high exposure to specialized REITs and industrial REITs. As can be seen from the pie chart below, specialized REITs and industrial REITs represent about 41.95% and 11.80% of FREL’s total portfolio respectively. Together, these two subsectors represent nearly 54% of FREL’s total portfolio. FREL’s specialized REITs include datacenters such as Equinix (EQIX) and Digital Realty Trust (DLR), communication towers such as American Tower (AMT) and SBA Communications (SBAC), and storage REITs such as Public Storage (PSA). Datacenter REITs will benefit from the demand of increasing data consumption and the desire for speed. Communication towers will benefit from wireless infrastructure upgrade to 5G technology. The outbreak of COVID-19 has accelerated these trends as people work from home and require quality and reliable digital infrastructures such as datacenters and communication towers.
Source: MSCI Website
Industrial REITs such as Prologis (PLD) and Americold Realty Trust (COLD) have already benefited from the trend towards people shopping online. The outbreak of COVID-19 also accelerated this trend as many people avoid going out and shop online instead. This trend is not expected to diminish anytime soon even after the pandemic is over. As can be seen from the chart below, retail e-commerce sales in the U.S. are expected to reach about $850 billion in 2022. This is significantly higher than 2019’s $600 billion. In addition, retail e-commerce sales will still only represent 15.5% of the total retail sales in the U.S. by 2022. Therefore, we still see a long runway of growth, and industrial properties will continue to be needed. In order to deliver products to end customers quickly, many retailers will need to establish more distribution centers and warehouses closer to their customers.
Source: S&P Global
FREL’s exposure to retail, office, and hotel REITs is limited
While some sub-sectors of FREL’s portfolio have done well in the pandemic, other sub-sectors such as retail, office, and hotel REITs have not done well this year. As we know, the outbreak of COVID-19 has impacted these cyclical sub-sectors negatively as people work from home, avoid shopping at brick-and-mortar stores, and reduce traveling. This trend is not expected to change in the near term unless COVID-19 can be contained quickly (it may depend on an effective vaccine). Fortunately, FREL has low exposure to these sub-sectors. In fact, these 3 sub-sectors only represent about 18% of the total portfolio. This is low when compared to its peer fund, iShares Core U.S. REIT ETF (USRT). These 3 sub-sectors represent over 24% of USRT’s portfolio.
Is it time to buy FREL right now?
FREL’s outlook as a whole should gradually improve as the economy recovers. How quick this recovery will happen depends on how quick COVID-19 can be contained. At this moment, it might take until mid-2021 before a safe vaccine is developed and it might take at least several months to 1 year for many people to receive a shot. Therefore, we do not think its fund price will recovery very quickly to the pre-crisis level. Nevertheless, we think the current low rate environment will support the valuation of many stocks in FREL’s portfolio. This is because REITs are generally sensitive to the change in interest rate. As can be seen from the chart below, FREL’s fund price is inversely correlated to the change in the 10-year treasury rate.
Data by YCharts
This rate environment is supportive of FREL’s valuation. The question is whether the treasury yield will move higher anytime soon. Fortunately, the Federal Reserve has vowed to continue to keep the rate at this low level until 2023. In addition, it has relaxed its 2% inflation target and will tolerate the inflation rate to be above 2%. This means that the interest rate will remain low perhaps for longer. Since REITs, generally, pay decent dividends with attractive yields, we think the current low interest rate environment will be supportive of FREL’s valuation.
We like FREL’s exposure to high-growth specialized and industrial REITs as these sectors should continue to do well regardless of a pandemic or not. It also has low exposure to sub-sectors that are being impacted by the outbreak of COVID-19. Investors will also receive a 3.7%-yielding dividend. Given that we will be in a low rate environment for a while, we think FREL is a good fund to own for investors seeking dividend income.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.