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A Funky Real Estate Fund Excels

Pimco RealEstateRealReturn Strategy uses derivatives and Treasury inflation-protected securities to beat its rivals.

Managers of most real estate funds seek to beat the competition by carefully researching real estate investment trusts or trying to forecast which kinds of properties will do better than others.

Not Mihir Worah, who runs Pimco RealEstateRealReturn Strategy (symbol PETDX). Instead, he uses derivatives. More specifically, he employs a type of swap that lets his fund keep pace with the returns of the Dow Jones Wilshire REIT index but that does not tie up the vast majority of the fund’s cash (according to the terms of these swaps, Worah pays out a return equivalent to the performance of London Interbank Offered Rate, or LIBOR, and receives a return equivalent to the REIT index’s performance).

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The approach allows Worah to use the bulk of the fund’s $487 million in assets to seek additional returns. He invests most of the money in a portfolio of Treasury inflation-protected securities, which he actively manages. How that portfolio of TIPS performs over any given period determines how the fund performs relative to the index, he says. From the fund’s inception in late 2003 through September 2, it earned 10.8% annualized, compared with the index’s gain of 8.1% a year.

In some sense, the fund’s strategy entails leverage. Although Worah doesn’t borrow money in order to invest greater than 100% of his fund’s assets, which would meet the narrowest definition of leverage, the strategy does magnify the fund’s exposure to certain risks. Investors flock to TIPS and real estate when they seek protection against inflation, but shun both in deflationary environments. “If we were to enter a period of prolonged deflation, you would get hurt on both sides,” Worah says. But TIPS are also Treasury bonds and so have performed well as Treasuries have rallied this year.

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Real-estate investments have been on a tear since early 2009. From the stock market’s bottom in March of 2009 through September 2, real-estate mutual funds have returned 156% on average, compared with the 66% cumulative gain of Standard & Poor’s 500-stock index. But the Pimco fund’s performance has been simply astonishing -- it has returned 261% cumulatively over that same period. Real estate stocks have also held up better than other sectors over the past few months as the overall market has retreated over concerns about the direction of the economy.

Worah says he doesn’t think REITs have become overpriced yet, but he does think the easy gains have been made. “A rising tide will not lift all boats” from today’s prices, he says. “I expect to see more differentiation in REITs’ performance from here on.” Of course, differentiating among specific REITs is precisely what Worah does not do in this fund -- he is bound to his REIT index. But his record of squeezing gains out of TIPS is so good that it might be worthwhile to buy this fund anyway.

The fund’s Class D shares are available from many online brokers without sales charge. Annual expenses are 1.14%.

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