KBWY: Despite Strong Yield, Focus On Small-Cap REITs Makes It Unattractive

~ by Snehasish Chaudhuri, MBA (Finance)

The Invesco KBW Premium Yield Equity REIT ETF (NASDAQ:KBWY) is an exchange-traded fund (“ETF”) based on the KBW Nasdaq Premium Yield Equity REIT Index. This index is constructed using a dividend-yield weighted methodology that seeks to reflect the performance of approximately 30 small-cap real estate investment trusts (“REITs”) in the United States.

KBWY is currently trading at $21.23, almost at par with its net asset value (“NAV”). The fund has an expense ratio of 0.35 percent, which is well under control. The fund pays a monthly dividend, generates a strong yield, but the total return is more or less equal to its yield only. KBWY seems to possess a higher risk than some other real estate investment trust (“REIT”) funds, and thus raises a question over sustainability of its yield.

Invesco KBW Premium Yield Equity REIT ETF is a High-Yield Generating ETF

The real estate market has a low correlation with traditional stock and bond investments. Traditionally, real estate has been considered an asset class that can generate excess returns during the bull markets. However, investing in real estate projects is a costly affair. REITs might appeal to investors seeking current income, as they offer an efficient way for investors to gain indirect exposure to real estate projects. Invesco KBW Premium Yield Equity REIT ETF provides further attraction by diversifying investors’ capital through a lot of such REITs.

This REIT fund was launched during December 2010 and has been paying a monthly dividend since then. During the past four years, annual average yield has been 7.78 percent. Yield during the trailing twelve months has been 6.9 percent. However, total return was not significantly higher, and annual average total return during 2016 and 2021 was 7.4 percent.

Invesco KBW Premium Yield Equity REIT ETF was launched and is managed by Invesco Capital Management LLC. The fund invests its $272 million assets under management (“AUM”) in public equity markets of the United States and fully replicates the composition of KBW Nasdaq Premium Yield Equity REIT Index. Keefe, Bruyette & Woods, Inc. and Nasdaq, Inc. compile, maintain and calculate this index, which is a modified-dividend yield-weighted index that seeks to reflect the performance of such companies. Both the Index and KBWY are rebalanced and reconstituted once in every four months – during the third Friday of March, June, September, and December. This rebalancing is primarily aimed at incorporating high-yield REIT stocks from time to time.

Composition & Performance of Invesco KBW Premium Yield Equity REIT ETF

The fund has invested significantly in some healthcare REITs and net lease REITs, such as Sabra Health Care REIT, Inc. (SBRA), Medical Properties Trust, Inc. (MPW), Omega Healthcare Investors, Inc. (OHI), Global Medical REIT Inc. (GMRE), National Health Investors, Inc. (NHI), Global Net Lease, Inc. (GNL), EPR Properties (EPR), Gladstone Commercial Corp. (GOOD), and Broadstone Net Lease, Inc. (BNL). These nine are among the top investments of KBWY, and constitute almost 30 percent of its entire portfolio. Over the past three months, barring OHI, all other stocks generated positive price growth. In my opinion, healthcare REITs and Net lease REITs have growth opportunities due to their limited supply and increasing demand in the coming years. However, its investment in office REITs and Retail & Hotel REITs raises risk.

More than 40 percent of KBWY’s assets are invested in office and Retail REITs such as Office Properties Income Trust (OPI), SL Green Realty Corp. (SLG), Brandywine Realty Trust (BDN), Vornado Realty Trust (VNO), Armada Hoffler Properties, Inc. (AHH), The Necessity Retail REIT, Inc. (RTL), Hudson Pacific Properties, Inc. (HPP), Getty Realty Corp. (GTY), Gaming and Leisure Properties, Inc. (GLPI), Apple Hospitality REIT, Inc. (APLE), Spirit Realty Capital, Inc. (SRC), Four Corners Property Trust, Inc. (FCPT), etc. In my opinion, most of these REITs are not among the most established and sought-after stocks in the U.S. stock market. Moreover, these segments of REITs have been mostly impacted by the sluggish macroeconomic situations during the Covid-19 pandemic and Russia’s invasion of Ukraine. Barring GTY and GLPI, no other stock was able to generate positive price growth during the past one year.

Is Investing in a Limited Group of Small-Cap REIT Stocks Helpful for KBWY

Although KBWY has selected the cheapest REITs, and some of these REITs performed well in the stock market, a majority of those stocks are in office REITs, retail & hotel REITs. These segments were highly impacted by the Covid-19 pandemic and Russia’s invasion of Ukraine, and small-cap REITs in those segments took the biggest hit. The fund has only 30 equity holdings, and the top 10 holdings constitute almost half of its AUM. More than half of its assets are invested in REITs that have a market capitalization of less than $2 billion.

Value investing always possesses a higher risk of failing. KBWY’s performance, too, is an example of a high-yield fund failing to generate a strong total return. Investors might get tempted to invest in such a small-cap REIT fund, but I wouldn’t be comfortable undertaking such a high degree of risk only for a steady yield. In other words, the yield may not be sustainable in the coming years in the absence of steady price growth of these small-cap REITs. Under such circumstances, KBWY loses its attraction as an investment opportunity despite generating a yield in the range of 6 to 8 percent and trading at par.

Investment Thesis

Invesco KBW Premium Yield Equity REIT ETF offers investors an attractive option to invest in small-cap REITs in the U.S., a market segment and asset class that has not been explored by a large number of investors since the unprecedented housing bubble in 2008. The fund pays a monthly dividend, generating a strong yield. In general, most small-cap or value-stock funds don’t possess a reputation of generating strong yields. At the same time, investing in real estate projects is not possible for individual investors with limited capital. So, income-seeking investors interested in the real estate sector should find KBWY attractive. However, despite sporting a market-leading yield, the fund’s performance has not been that impressive in terms of total return.

The Invesco KBW Premium Yield Equity REIT ETF was battered twice; first, it was the coronavirus pandemic, and then the monetary tightening of central banks in order to tame down inflation arising out of Russia’s invasion of Ukraine. Moreover, investing in a small group of small-cap REITs creates a high degree of risk with regard to its portfolio. Value investing always possesses a higher risk of failing, and I am of the opinion that this more likely was one of the drivers behind Invesco KBW Premium Yield Equity REIT ETF’s lackluster performance. In sum, Invesco KBW Premium Yield Equity REIT ETF investors may have exposure to a brilliant value mix, but this is one of those disappointing examples when the value style simply does not work.