Q4 2020 Commentary: Real Estate Credit ETF (REC)

The Emles Real Estate Credit ETF (REC) seeks to track the price and yield performance, before fees and expenses, of the Solactive U.S. Real Estate Bond Index, a market value weighted index designed to measure the performance of corporate bonds issued by U.S. companies in the real estate sector. 

Performance summary of Q4 2020

Since the Fund’s inception on October 14, 2020, the Fund has gained 2.9% as of December 31, 2020. This return compares favorably to a 2.0% return delivered by the corporate bonds¹ and a 5.8% return from the equity REITs² over the same time period. Importantly, this return came during a quarter with elevated levels of economic, political and policy uncertainty.

• Contributors: The Fund’s five largest sectoral allocations, infrastructure, retail, healthcare, specialty and office, were all up since inception, with significant outperformance for lodging/resorts and specialty REITs
• Detractors: There were no significant detractors, with data centers and timber flat to slightly down. The Fund’s large allocations to retail (15.6%), healthcare (14.1%), office (9.2%) and lodging/resorts (6.8%) continue to remain under pressure given COVID concerns; however, negative performance has been tempered by positive vaccine sentiment and long-term expected value accretion
• Outlook: Infrastructure, retail and healthcare remain the top sectoral exposures for the fund, as we expect increased demand following a 2021 reopening

Quarter in review

• The Fund outperformed its index by 0.14%, with its total return comparing favorably to a 2.0% return delivered by the Bloomberg Barclays U.S. 5-10 Year Corporate Bond Index.
• Specialty REITs were the top contributor to total return due predominantly to the Fund’s allocation to EPR Properties, which owns ski resorts, waterparks, family entertainment centers, golf attractions, and movie theaters. Prior to the Funds’ inception, EPR was hit hard by the COVID-19 pandemic but recovered in Q4 as people felt more comfortable about the longer-term outlook for travel and entertainment. Going forward, strong underlying collateral value of the properties may help protect credit investors and pent-up demand may allow for a rapid rebound once local economies reopen.
• Prior to the Funds’ inception, the property sector significantly underperformed due to a rapid decline in occupancy following travel restrictions. However, the sector rallied after positive vaccine news in November; lodging/resorts contributed to total returns this quarter and have created leaner operating models in the face of limited supply growth.

Looking ahead

• We expect performance across property sectors to vary in 2021, with the sectors most directly affected by shutdowns, such as lodging/resorts and retail, poised to recover in 2021. Declines in 2020 allow for upside potential as the economy returns to more normal conditions following the vaccine.
• It’s important to distinguish between effects of the pandemic versus permanent changes to the real estate market. For example, work-from-home arrangements may have ongoing long-lasting effects on office markets, as well as retail, apartments, etc.
• Infrastructure, retail and healthcare remain the top property sector exposures for the Fund:
• Infrastructure: In the short term, we expect firms to continue to outsource IT infrastructure, creating strong demand and robust pipelines. However, this will be netted against elongated sales cycles due to the pandemic. In the long term, the rising adoption of cloud, 5G and digital applications will be a significant driver of growth.
• Healthcare: Healthcare REITs may stand to benefit from pent-up demand on senior-housing facilities and improved occupancy levels. Demand for life-science and medical office buildings has held up in 2020, which may help keep occupancy elevated and cash flow growing in 2021.
• Retail: We anticipate that malls and shopping centers will continue to be challenged with erosion of tenant quality and rental cash flows; however, higher quality assets and other niche properties should continue to perform. Retail REITs may be able to increase occupancy by the second half of 2021; hybrid models such as online orders with curbside pickup that could transform the sector.
• Overall, we believe that the improving balance sheet fundamentals, as well as the Fed’s backstop to corporate debt, should continue to drive issuance as well as returns in the real estate credit markets.

Full performance and holdings information can be found here.