Role of Farm Real Estate in a Globally Diversified Asset Portfolio

The paper examines the benefits of further diversifying a global portfolio of financial assets with New Zealand farm real estate (FRE) using modern portfolio theory. We compare efficient sets generated with and without farm real estate. The results show that given the predominantly negative correlation between FRE and financial assets, the risk-return tradeoffs of portfolios of financial assets can be improved significantly. The diversification benefits measured in terms of risk reduction, return enhancement, and improvement in the Sharpe performance ratios are robust under a number of FRE risk-return scenarios as well as under high and low inflationary periods. Using 5- and 10-year rolling periods we also find that FRE is a consistent part of risk efficient portfolios. The results also show that risk reduction benefits of diversifying with FRE are larger than the risk enhancement benefits. This suggests a role for FRE in mixed asset portfolios that typify more of a risk-reducer rather than a return-enhancer. The practical implication of our findings is that investors can significantly enhance their portfolio risk-return tradeoffs, particularly by reducing risk, through diversification into FRE. FRE therefore appears to deserve more serious consideration by investment practitioners that it has been accorded in the past. We conjecture that such is the result of limited avenues by which they can invest in FRE. Therefore, it is also important to explore ways of making it easier for investment practitioners to invest in FRE probably through the wider introduction and development of unit trusts investing in direct FRE.