Mixed-asset Portfolio Research Articles

Has Real Estate Come of Age?

Executive Summary. This paper reveals the limitationsof the classic Modern Portfolio Theory (MPT) and thefallacy of applying this theory to a mixed-asset portfoliothat includes real estate. The findings suggest that thevalidity of the single-period MPT to multi-period investmentis critically conditional on the assumption that assetreturns over time are independent and identicallydistributed (i.i.d.) and that the real estate returns are farfrom this assumption. Furthermore, the analysis showsthat the unique characteristics of real estate greatly complicatethe mixed-asset portfolio decisions, and the longstanding "real estate allocation puzzle" may be causedby the direct application of MPT to the mixed-assetportfolio.

Mental Accounting and False Reference Points in Real Estate Investment Decision Making

This study examines a number of behavioral finance issues as they relate to real estate investments. We find a statistically significant degree of mental accounting at all points throughout the disposition effect curve when holding a real estate investment in isolation versus holding the asset as part of a mixed-asset portfolio. We also identify four distinct disposition curve shapes beyond the traditional “S-shaped” curve, where investors are more willing to sell an asset that is in the gains domain. Furthermore, we conclude that an investor's willingness to sell jumps by the greatest amount when going from zero return into profitable territory. Finally, this false reference point does take into consideration transaction costs.

Real Estate Allocation Puzzle in the Mixed-Asset Portfolio: Fact or Fiction?

Direct application of Modern Portfolio Theory (MPT) to the mixed-asset portfolio often suggests that allocation to real estate should be far more than what is practically acceptable. This paper reveals that the puzzling gap is caused by inappropriate application of MPT using only short-term (quarterly or annual) real estate performance measures. Our findings suggest that (1) the validity of MPT (the single-period model) to multi-period real estate investment is critically conditional upon the assumption that asset returns over time are independent and identically distributed (i.i.d.), and (2) the i.i.d. condition is strongly rejected by real estate data. As a result, real estate return and risk are holding-period dependent. We show that once real estate performance is measured over more realistic holding periods - which are longer due to illiquidity and high transaction cost - the real estate allocation puzzle appears to be fiction rather than fact.

Correlation and Volatility Dynamics in REIT Returns: Performance and Portfolio Considerations

In this article, the authors examine the dynamics of the correlation and volatility of REITs, stocks, and direct real estate returns using monthly data from January 1987 to May 2008. In order to explore asymmetries in conditional correlation, the authors use a multivariate asymmetric dynamic diagonal conditional correlation (AD-DCC) GARCH specification. They document that the time-varying conditional correlations can be explained by macroeconomic variables, such as term and credit spreads, inflation, and the unemployment rate, and they find a strong relationship between correlations and REIT returns and that the patterns are distinguishable for different types of REITs. Interestingly, when the correlation between REITs and the SP that is, the higher (lower) correlation between equity REITs and direct real estate, the higher (lower) the future returns of equity REITs. The authors’ results have economic implications regarding the time-dependent diversification benefits of REITs in a mixed-asset portfolio and the unique risk and return characteristics of REITs.

The Changing Benefit of REITs to the Mixed-Asset Portfolio

Executive Summary. A number of studies have examined the allocation of public real estate securities (REITs) in the mixed-asset portfolio. Yet no study has explicitly examined what benefits REITs offer to the traditional capital market mixed-asset portfolio (i.e., whether REITs are a return enhancer, diversifier, or both). This paper examines this issue using the method suggested by Liang and McIntosh (1999), which decomposes the overall risk-adjusted benefits of an investment to an existing portfolio into its diversification benefits and return benefits. The results show that REITs offer different benefits to different asset classes and the mixedasset portfolio and that these benefits have changed over time. Thus, whether REITs can have a place in any future mixed-asset portfolio largely depends on the relative return performance of REITs versus the alternative asset classes within the mixed-asset portfolio.

The Development and Performance of REITs in Hong Kong

Hong Kong is one of the most dynamic commercial property markets in Asia. With the recent development of REITs in Asia, HK-REITs have become an important property investment vehicle in Hong Kong since 2005. This paper assesses the significance, risk-adjusted performance and portfolio diversification benefits of HK-REITs in a mixed-asset portfolio in Hong Kong over 2005–2008. The impact of the global financial crisis on HK-REITs and the ongoing strategic development of HK-REITs are also assessed. HK-REITs are seen to deliver strong risk-adjusted returns and to have been robust during the GFC with superior risk-adjusted returns to other listed asset classes, but some loss of diversification benefits was also evident in the GFC.

The Impact of REOCs and Public Mortgage Finance Companies on the Performance and Volatility of U.S. REITs

Executive Summary. This paper extends the evidence on the financial performance of real estate investment trusts (REITs) by analyzing whether U.S. REIT index returns are impacted by other domestic firms that primarily engage in real estate activities but are not structured as REITs such as real estate operating companies (REOCs) and mortgage finance companies (MFCs). There is strong evidence that U.S. REITs are impacted by these other firms engaged in mortgage financing activities; thus underscoring the linkages between the overall capital markets and real estate performance. These results can be attributed to the changing dynamics of the real estate sector and its significant interrelationships. The findings have strong implications for constructing mixed-asset investment portfolios.

Homeownership and Mixed–Asset Portfolio Allocations

Homeownership and Mixed–Asset Portfolio Allocations

Diversification Benefits of Real Estate Investment Trusts in Dubai

This paper examines whether unleveraged REITs in Dubai help optimize the risk/return characteristics of a mixed asset portfolio. The performance is also analyzed using Shariah compliant REIT structures incorporating discussion of the performance of REITs operating in a zero-tax environment within the Modigliani and Miller (1958) framework. The empirical results confirms that investment in real estate via Dubai REITs would have substantially improved the performance of a mixed asset portfolio through its ability to hedge inflation, enhance returns and reduce volatility. These characteristics persisted under sensitivity testing. Furthermore, the conclusions find that leveraging the REIT produced increased risk without providing risk/return benefits.

Do Asian real estate companies add value to investment portfolio?

PurposeThe purpose of this paper is to examine the role of Asian real estate companies with regard to their “value‐added” performance and portfolio diversification benefits in Asian mixed‐asset portfolios, as well as in international real estate securities portfolios over 1996‐2005.Design/methodology/approachFirst the risk‐return performance for all 13 Asian as well as the US and UK real estate securities markets is compared. For each country, next the correlation profiles between real estate, common stock, bonds and cash are assessed. The value‐add benefits of Asian real estate securities in an unconstrained and constrained mixed asset portfolio are then assessed in relation to portfolio return, risk and terminal wealth. Finally, the paper explores whether there are benefits derived from international diversification with a universe of Asian real estate securities from the perspectives of the US and UK investors.FindingsIt was found that, whilst there is little evidence of diversification benefits and superior risk‐adjusted performance of Asian real estate companies in Asian mixed‐asset portfolios, diversification into Asian real estate stocks can provide positive portfolio implications for international investors. Thus investing in Asian real estate securities portfolios rather than investing in Asian mixed‐asset portfolios may be seen to be the more effective diversification strategy over this period.Originality/valueThe study has provided some interesting and important insights into the dynamics and performance of Asian real estate securities. With an increased emphasis on international property investment and as the regional upturn becomes more evident, Asian real estate companies potentially provide an important real estate investment opportunity for international property fund mangers.

ETF Short Shares: The Next Stage in the Evolution of REIT Ownership

Executive Summary. This study introduces a new publiclytraded real estate security known as an ExchangeTraded Fund (ETF) Real Estate Investment Trust(REIT) short share. In addition to examining the return,correlation, autocorrelation, partial-order autocorrelation,stationarity, and Granger Causality characteristicsof this new investment vehicle, we demonstrate thatREITs warrant inclusion in mixed asset portfolios tovarying degrees regardless of which direction the investorfeels the REIT market is headed.

An analysis of the impact of timberland, farmland and commercial real estate in the asset allocation decisions of institutional investors

We examine the effects of including timberland, farmland and commercial real estate in a mixed asset portfolio with stocks, government bonds and T-Bills. Using both smoothed and unsmoothed returns (as per Geltner [Geltner, D. (1993). Estimating market values from appraised values without assuming an efficient market. Journal of Real Estate Research, 8, 25–345.]) and both constrained and unconstrained allocation assumptions (as per Eichhorn, Gupta and Stubbs [Eichhorn, D., Gupta, F., & Stubbs, E. (1998). Using constraints to improve the robustness of asset allocation. Journal of Portfolio Management, Spring, 41–48.]), we employ Markowitz portfolio optimization and find widely varying allocation outcomes. However, timberland entered nearly all portfolios, accounting for large percentages in several scenarios, while farmland entered only low-risk portfolios. At lower risk levels, commercial real estate dominates the real estate allocation but as acceptable risk levels rise, timberland supplants commercial real estate as the primary component of the portfolio's real estate allocation.

Homeownership and mixed-asset portfolio allocations

Homeownership represents both a consumption and an investment decision for individuals. Considering the investment benefits of the home, we estimate the total returns and risk associated with the investment in single-family homes. Then, using a mean–variance utility function, we consider the impact of homeownership and mortgage loan financing on the optimal asset allocation decisions of individuals and contrast this with advice that does not include the home as part of the portfolio. While optimal portfolio weights are dependant upon both the degree of risk aversion of the individual investor and the relative importance of the home in the overall net worth picture, we show that, in general, the higher the home-to-net worth ratio, the higher the optimal portfolio allocation to stock. For most investors, including the home in the optimization decision leads to higher allocations to risky stock than suggested by traditional advice that ignores the home.

A mixed R&D projects and securities portfolio selection model

The business environment is full of uncertainty. Allocating the wealth among various asset classes may lower the risk of overall portfolio and increase the potential for more benefit over the long term. In this paper, we propose a mixed single-stage R&D projects and multi-stage securities portfolio selection model. Specifically, we present a bi-objective mixed-integer stochastic programming model. Moreover, we use semi-absolute deviation risk functions to measure the risk of mixed asset portfolio. Based on the idea of moments approximation method via linear programming, we propose a scenario generation approach for the mixed single-stage R&D projects and multi-stage securities portfolio selection problem. The bi-objective mixed-integer stochastic programming problem can be solved by transforming it into a single objective mixed-integer stochastic programming problem. A numerical example is given to illustrate the behavior of the proposed mixed single stage R&D projects and multi-stage securities portfolio selection model.

Home Builder Stocks in Mixed-Asset Portfolios

Executive Summary. The purpose of this study is to examine the long-run performance of homebuilder stocks and the potential role of the sector in institutional mixed-asset portfolios. Considering a 30-year history of returns of common stocks, corporate bonds, REITs, T-bills, and homebuilder stocks, homebuilder stocks dramatically outperform all other asset classes, although superior performance is not significant on a risk-adjusted basis. However, the relatively low correlations between home-builder stocks and stocks and bonds make it beneficial to include homebuilder stocks in a mixed-asset portfolio. The study employs a bootstrap procedure to investigate the diversification benefits under the condition of certainty as well as uncertainty. The findings reveal that including homebuilder stocks can improve the mean-variance efficiency of portfolios that contain only traditional financial assets such as common stocks, bonds, and T-bills.

Will Private Equity and Hedge Funds Replace Real Estate in Mixed-Asset Portfolios?

The role of commercial real estate in the investment portfolios of institutional investors is now well established, and allocations towards real estate are increasing. However, fund managers are also gaining interest in alternative asset classes such as hedge funds, private equity, commodities, and infrastructure. This raises the question of whether real estate could fall out of favor with institutional investors. To investigate this issue, the authors examine historical return data from a wide range of asset classes. They find strong support for increasing allocations towards real estate and that real estate has significantly better risk-hedging characteristics than any of the other asset classes studied. <b>TOPICS:</b>Real estate, portfolio management/multi-asset allocation, risk management

Emerging Market Bonds as an Asset Class

Emerging market bonds improve the efficient frontier of a mixed-asset portfolio. The improvement is based on the application of mean-variance spanning tests on returns that are free from survivorship bias. The results indicate that emerging market bonds span a portfolio comprised of U.S. stocks, U.S. bonds, international equity, and international bonds from developed markets. Mean-variance optimizations suggest that a typical fund sponsor might consider overweighting its allocation towards emerging market bonds. <b>TOPICS:</b>Emerging markets, fixed income portfolio management, portfolio construction

Marketing Period Risk in a Portfolio Context: Theory and Empirical Estimates from the UK Commercial Real Estate Market

The role of selling (or marketing) period uncertainty in understanding risk associated with property investment is examined in this paper. Using an approach developed by Lin (2004), and Lin and Vandell (2001, 2005), combined with a statistical model of UK commercial property transactions, we show that the ex ante level of risk exposure for a commercial real estate investor is around one and a half times that obtained from historical statistics. The risk related to marketing time uncertainty can be reduced by constructing a portfolio. We find that at least ten properties are necessary to reduce this risk, assuming independence between marketing period risk and price risk. These findings have important implications for mixed-asset portfolio allocation decisions.

Spanning Tests on Public and Private Real Estate

Executive Summary. This study uses mean-variance spanning tests to examine the roles of public and private real estate in mixed-asset portfolios. The results suggest that the usefulness of including equity real estate investment trusts (REITs) in improving investment opportunity sets is sensitive to the specification of benchmark assets. In contrast, private real estate yields diversification benefits in various specifications of benchmark assets. The results imply that, when private real estate is already in a mixed-asset portfolio, there is limited room for equity REITs. Equity REITs are substitutes for private real estate in a mixed-asset portfolio when direct investing in private real estate is not feasible because of liquidity, transaction costs, and economies of scale. This result explains why large fund sponsors tend to allocate more to private real estate than to public real estate.

The Mixed Asset Portfolio for Asia-Pacific Markets

Executive Summary.In this study, mixed-asset portfolios were constructed containing real estate, common stock, and bond investments from various Asian-Pacific countries. The countries of particular interest include six economically developing countries: China, Indonesia, Malaysia, the Philippines, South Korea, and Thailand, and five developed countries: Singapore, Japan, Hong Kong, Australia, and New Zealand. The time period is 1998-2005. Upon close examination of these portfolios, it becomes clear that currency risk is a larger concern when investing in countries with emerging markets in comparison to countries with already developed markets. Despite the currency risk, the results of this study show that mixed-asset portfolios from countries with emerging economies have outperformed the assets of developed countries for moderate and aggressive investors targeting Asian-Pacific countries.