IndexIQ, the issuer perhaps best known for its hedge fund replication ETFs, rolled out the latest addition to its growing suite of small cap lineup today: the IQ U.S. Real Estate Small Cap ETF (ROOF). The new product will be the first to offer exposure exclusively to small cap U.S. REITs, seeking to replicate the IQ US Real Estate Small Cap Index. That benchmark includes about 35 individual securities with a weighted average market capitalization of just over $1 billion; the underlying index is constructed by taking the bottom 10% of the market capitalization of U.S. REITs, subject to certain minimum market capitalization and average daily trading volume restrictions.
ROOF becomes the 17th ETF in the Real Estate ETFdb Category, but the first to focus only on small cap stocks. That distinguishing feature may give the new ETF a unique risk/return profile; small cap REITs have put together an impressive track record in recent years relative to their large cap counterparts, and may also have appeal as acquisition targets. The most popular ETF for establishing REIT exposure is the Vanguard REIT Index ETF (VNQ), which has about $9 billion in assets. The largest component in that fund is Simon Property Group (SPG), which has a market capitalization of more than $30 billion. VNQ consists primarily of large cap and mid cap stocks; small caps make up less than 20% of the total portfolio, and there is virtually no overlap with the new IndexIQ fund [ETFs For The Forgotten Asset Classes].
ROOF spreads exposure across various corners of the real estate market; the related index includes meaningful allocations to mortgage REITs (21%), retail REITs (18%), office REITs (18%), hotel REITs (17%). Exposure is spread relatively evenly across the component securities; no one name makes up more than about 6% of the underlying index.
ROOF will charge an expense ratio of 0.69%, within the range (0.12% to 0.80%) of existing products in the Real Estate ETFdb Category.
Appeal Of ROOF
ROOF offers both attractive yields and valuations relative to large cap REIT ETFs. The index that ROOF seeks to replicate has a price-to-book ratio of about 1.30. The same metric for the iShares Dow Jones U.S. Real Estate Index Fund (IYR) comes in at about 2.30x. The index replicated by ROOF also features a dividend yield in the neighborhood of 5%–well above payouts offered by large cap real estate ETFs (IYR’s distribution yield comes in around 3.4%). Small cap real estate ETFs have also performed quite well in recent years compared to their large cap counterparts, including outperformance during the real estate freefall in 2008 and subsequent recovery in 2009 and 2010.
REITs are popular tools for investors looking to beef up current returns; in order to remain eligible for certain tax benefits, these entities must pay out a significant portion of total assets. So because ROOF offers a relatively attractive distribution yield and has little overlap with other REITs, it can be a potentially useful tool to enhance both the current return and diversification of a portfolio [see Dividend ETF Special: 25 High Yielding ETFs].
“Performance among both small- and large-cap REITs took a big hit at the start of the financial crisis in 2007, but since 2009, REITs have seen a performance resurgence, with small-cap offerings far outpacing the performance of their large-cap counterparts,” said Adam Patti, CEO of IndexIQ, in a press release. “In today’s environment, investors are hungry for income producing assets. With ROOF, ETF investors now have the potential to capture a robust new income stream and significant capital appreciation by isolating small cap US real estate exposure; and they can do this in a transparent, liquid, tax efficient way.”
IndexIQ: Activity Continues
The launch of ROOF continues a busy stretch of new product development for IndexIQ; the company has now added five ETFs to its lineup in 2011, many of which focus on small cap stocks. In addition to small cap options for energy stocks (IOIL), Hong Kong equities (HKK), and agribusiness companies (CROP), IndexIQ has also rolled out a mid cap Japanese ETF (RSUN) this year. CROP has become one of the most popular new ETFs of 2011, picking up more than $50 million in AUM in less than three months.
Disclosure: No positions at time of writing.