Portfolio Potential
In order to estimate the extent of the risk-reduction potential for global real estate securities within a mixed asset portfolio, historical average returns (data sets of returns, volatilities and correlations of all of the asset classes) were used to construct a series of efficient portfolios. A portfolio is efficient when it offers the highest return for a given level of risk—or, alternatively, the lowest risk for a given level of return.
Figure 3 illustrates two portfolios that were constructed based on the data series. The first is a portfolio consisting of global equities and global bonds. The lower of the two lines represents the maximum return at given levels of risk for the equity and bond investors over the 18-year period. At the midpoint of the examined risk-return scale (about 9.5%), the portfolio could have achieved a maximum return of approximately 8.2%.
The second portfolio builds on the first by adding global real estate securities. The addition of global real estate securities to an equity and bond portfolio added significant value to the portfolio at the midpoint of the examined risk/return scale (148 basis points of additional return while holding risk constant). Incremental portfolio returns are even greater at higher riskreturn preference levels.
Therefore, simply by adding global real estate securities to existing mixed asset portfolios consisting of equities and bonds, investors could have realized added returns without added risk. This would have been achieved due to differing risk-return profiles and low correlations of global real estate securities to bonds and equities—in other words, maximizing the power of diversification.
Risks and Rewards
When determining whether or not to include global real estate securities in a portfolio, there are certain risks that need to be recognized. Because these securities are traded on stock exchanges on a daily basis, there will be much greater volatility associated with this asset class than with direct real estate. Also, there may be periods over the short term in which market trading momentum will cause global real estate securities to perform in line with the general equity markets.
However, the results of the study suggest that, over the long-term, investors can realize additional incremental portfolio returns through investment in global real estate securities, due to the sector’s tendency to behave more like private direct real estate. Long-term investors should consider an allocation to this asset class. Diversification can be achieved efficiently through investment in dedicated, actively managed portfolios of global real estate securities, which are gaining in popularity among institutional and individual investors. The benefit to investors is to help them achieve appropriate geographic and sector diversification, with the overall goal of minimizing risk while also increasing returns.
Todd A. Canter is the chief executive officer of Asia Pacific and global strategist with LaSalle Investment Management (Securities). Patrick Elliott is an associate in the strategy and global product development group with LaSalle. todd.canter@lasalle.com; patrick.elliott@lasalle.com
> click here for a PDF version of this article
© Copyright 2008 Rogers Publishing Ltd. This article first appeared in the October 2008 edition of BENEFITS CANADA magazine.