Wells Fargo: Cut REIT exposure and add emerging market bonds

World currencies

Real-estate investment trust (REIT) valuations are still at a discount, but it’s time to cut exposure and reallocate into emerging market fixed income, Wells Fargo Investment Institute said in a note last week.

“Real estate investment trusts (REITs) have become more sensitive to interest rates, which we expect to rise further in 2018 and 2019. In our view, this headwind increasingly will offset the valuation discount and mostly sound REIT fundamentals,” it said, adding that it was shifting to a more neutral outlook.

That’s despite the average REIT trading at a 7 percent discount to its underlying real estate holdings, compared with an average 2.3 percent premium to underlying holdings since 1990, it said. It also noted that the FTSE EPRA/NAREIT Developed Total Return Index is trading around an all-time high.

Wells Fargo advised reducing REIT exposure and reallocating into U.S. dollar-denominated emerging market fixed income.

“We view return opportunities for Emerging Market Fixed Income as more compelling than those for Public Real Estate,” it said. “In recent weeks, the sell-off in emerging-market assets generally, and the renewed rise in U.S. Treasury yields, has substantially improved valuation in this asset class.”

JP Morgan Emerging Markets Bond Index Global (EMBIG) yields have increased to over 6.5 percent, it noted.

“At these levels, we believe that the yields offer an added cushion against risks and raise our expected 12-month return for this debt class,” Wells Fargo said, adding that the recent selloff was due to temporary factors.

For one, it noted that with U.S. Treasury yields’ recent rise, there is less room for further increase. It said that it believed the U.S. dollar’s rally had already mostly played out, adding it expected that the widening U.S. trade and federal budget deficits will push the greenback back on a depreciation trend, spurring new emerging market debt buying.

Wells Fargo also said it it believed recent trade war fears may be overblown. Those fears had spurred emerging market turbulence.

“If our outlook is correct, emerging-market yields very likely have risen too far. These higher yields present a compelling buying opportunity (in our view),” it said.

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