Sector, region or function? A MAD reassessment of real estate diversification in Great Britain

Purpose - This paper aims to re‐examine the portfolio risk/return performance of “conventional” sector/regional classifications with one based on socio‐economic criteria. Design/methodology/approach - Applying the mean absolute deviation (MAD) portfolio optimisation method, this study revisits sector versus regional diversification within the UK using the Investment Property Databank (IPD) annual data over the period 1981‐2007. A modern functional classification, with data from the 2001 Census, is used to retest the proposition that such groupings may offer superior diversification benefits. Findings - In line with previous research, sectors dominate regions, however defined, and should be the first level of analysis when developing an optimised portfolio diversification strategy. When the performance of functional groups is compared with “conventional” administrative regions results show that such groupings can provide greater risk reduction. The underlying characteristics of these functional groups may be more insightful and acceptable to real estate portfolio managers in considering assets that a portfolio might contain. Originality/value - Real estate markets are thought to be dynamic, in that their form and content can change dramatically even over quite short periods. This paper shows it is actually rather unlikely that matching changes in the structures of real estate investment portfolios will be observed, even over extended time periods, except at their margins. Although efficient frontiers move across the MAD risk/return space, the relative positions of the sectors and regions hardly change at all in pure analytical terms. In particular, the use of functional groupings, which reflect the greatly changed economic landscape in Britain over some 20 years, do not presage any great change in the pattern of institutional real estate investment, nor even a very obvious improvement in the portfolio performance.