Vanguard announced a change to their REIT Index fund’s investment objective. The fund has historically tracked the MSCI US REIT Index. Starting mid 2018 the fund will track the MSCI US IMI Real Estate 25/50 Index. Is it possible these upcoming changes present an opportunity?
What are the major differences?
There are some big differences between the two indexes. Lets take a look at the top 10 weighted companies of each index:
|US REIT (OLD INDEX)||Weight %||US IMI REAL ESTATE 25/50 (NEW INDEX)||Weight %|
|SIMON PROPERTY GROUP||5.87||AMERICAN TOWER CORP||5.71|
|EQUINIX||4.20||SIMON PROPERTY GROUP||4.72|
|PROLOGIS||4.08||CROWN CASTLE INTL CORP||4.25|
|WELLTOWER INC||2.87||PUBLIC STORAGE||3.11|
|EQUITY RESIDENTIAL||2.85||WEYERHAEUSER CO||2.48|
|DIGITAL REALTY TRUST||2.78||AVALONBAY COMMUNITIES||2.33|
|BOSTON PROPERTIES||2.24||EQUITY RESIDENTIAL||2.29|
Let’s take a look at the big changes in top 10 positions. As a result of these changes Vanguard will be making American Tower ($AMT) and Crown Castle ($CCI) top 10 positions in their fund. American Tower and Crown Castle are highly correlated. Combined they will account for 10% of the fund. A typical passive index investor would probably prefer to avoid this level of concentration. For our purposes one thing matters. Vanguard will be buying a bunch of stock in $AMT and $CCI.
Can index changes create a trading opportunity?
Yes they can. Here are some examples:
- In 2012 Fairfax Financial was kicked out of the MSCI Canada Index. Shares were down almost 10% because an index fund was unloading. Luckily I was looking at Fairfax’s stock price that day and noticed the drop. I bought without knowing the reason for the drop until later in the day. Better lucky than good 🙂 Had I been following MSCI index changes I would have known ahead of time and planned accordingly.
- In February 2010 Berkshire Hathaway ($BRK.A $BRK.B) was added to the S&P 500 index. That day it traded up over 1% on heavy volume. The market knew ahead of time when Berkshire Hathaway was getting added to the index. Furthermore the stock had rallied based on the initial news of the addition. Yet still it traded up that day.
As you can see trading opportunities sometimes arise as a result of index changes.
Will $AMT and $CCI soar on Vanguard’s buying?
Will $AMT and $CCI rally into 2018? The Vanguard REIT ETF and mutual fund manage $65 Billion of assets. At a 5.7% index weighting they would need to buy $3.7B of American Tower. At 4.25% they would need to buy $2.7B of Crown Castle. These positions will account for approximately 6% of each companies market cap.
|Stock||Market Cap||Index Weighting||Expected position. Assuming 65B in assets.||Position as percentage of market cap.|
|$AMT - American Tower||60.97B||5.71%||3.7B||6%|
|$CCI - Crown Castle||45.10B||4.25%||2.7B||5.9%|
According to this article on etf.com the funds will use a transition index for the first part of 2018 to reduce frictional costs of moving from one benchmark to another and complete the transition by the middle of the year. I don’t know anything about the mechanics of this transition but it seems likely there will be some upward pressure on these stocks in the first half of 2018.
This situation is different from the Berkshire and Fairfax special situations I mentioned earlier. In those situations the indexes changed the stocks they were tracking. Furthermore the changes happened on a specific date. In this case the make up the indexes are not changing. The Vanguard fund is changing the index it is tracking. Vanguard can probably manage this in a more controlled and leisurely fashion to reduce impact on market price.
Therefore it will be interesting to keep on eye these two stocks over the first half of 2018. It might be fun to express this buying a few calls or selling a few puts. At the moment I have no plans to take any action other than observing.
Interested in other REIT stocks?
Check out our list of US based publicly traded REITs.