The case for listed real estate in a multi-asset portfolio

07 Feb 2015

In this paper we present the argument that investors should acknowledge the potential of listed real estate1 to act as a proxy for direct property in a portfolio and the positive contribution that it can make to a multi-asset portfolio. In a recent survey on the behavior of investors towards listed real estate, Moss and Baum (2013) find that some asset allocators still dismiss listed real estate from their portfolios despite the belief from others that real estate should generate attractive income and returns.

Evidence from the research presented here confirms that investors should reassess their dismissal of listed real estate. The asset class plays an important role in multi-asset portfolios in terms of generating diversified returns with a stronger income component arising from high dividends, while protecting against inflation and interest rate raises. Moreover, even if in the short-term listed real estate may be correlated with equity markets, we show that in the long-term it does offer an exposure to direct real estate2 while avoiding the well-known illiquidity issues associated with owning a portfolio of buildings.

The illiquidity of direct real estate is indeed one of the problems that listed real estate can address. Certain segments of the real estate market that are more difficult to access due to the large amount of capital required to invest in them became readily accessible to the smaller investors through listed real estate. And even for larger investors, this means that listed real estate offers the possibility to more easily allocate, and manage the exposure to, different segments of the market in a portfolio than if only direct real estate is considered.

Real estate contributes to portfolio diversification in a number of ways. In the short-term, its relatively high correlation with risky asset classes like equities limits the diversification benefit from an ex-ante risk point of view but robust optimization techniques show that listed real estate should still be added to a multi-asset portfolio for diversification against uncertainty in return forecasts and variance-covariance forecasts. In the long-term, listed real estate tends to show low correlations with other asset classes and thus the benefit in terms of diversification is more naturally observed.

In addition, we should also not overlook the underlying real estate exposure that REITs3 and REOCs4, provide in terms of diversification through the ownership of portfolios of multiple properties, rather than investments in single properties.

From a broader investment management perspective, portfolio managers can recognize the potential benefits from adding listed real estate to a multi-asset portfolio. Managers have the potential to generate additional uncorrelated alpha from exploiting inefficiencies in the asset class both at top-down and bottom-up level as we shall see later. Listed real estate offers opportunities for active management which are not typically exploited in either equities or direct real estate.

In view of the sensitivity of real estate to both interest rates and given current market concerns that interest rates will eventually rise, the study examines the sensitivity of listed real estate to movements in short term and long term rates. In addition, the analysis looks into how effective inflation hedge property equities are over the longer term.

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