Diversification Gains and Systematic Risk Exposure in International Public Real Estate Markets

In this paper, we re-examine the benefits of holding a portfolio of international real estate securities in the light of evidence of growing co-movement of securitised asset returns across markets. Do diversification benefits depend on how integrated or independent the firms and countries are at global or regional level? Specifically, can more risk reduction be achieved through holding international diversified investments in segmented markets rather than co-integrated markets? If so, is it possible to identify the extent of this effect, hence informing global investor strategy, particularly in the light of a growing integration within global securities markets? The paper develops studies such as Wilson and Zurbruegg (2003), Gerlach et al. (2006) and Gallo and Zhang (2010) in focussing on the cointegration between markets, but extends that work in seeking to identify the sources of difference and in investigating the impact of cointegration on the sensitivity of asset returns to factor risks. Cointegration is captured using a variety of techniques: ADF, PP, KPSS and Zivot and Andrews. From these tests, we produce two portfolios of “cointegrated” and “independent” indices and assess whether they differ in terms of risk-adjusted return. We examine Sharpe ratios and sensitivity to systematic risk, using a range of multi-factor models, decompose portfolio risk using a Fama-Macbeth approach and apply a canonical approach to test sensitivity to macro-economic and financial risk factors. The paper utilises data from GPR’s international real estate company database. Monthly returns 1997 to 2011 from individual firms are aggregated to produce value-weighted indices for 19 countries) and five regions. We also examine company returns by sector and, separately, examine firms that are based or predominantly invested in international financial centres. In the analysis presented here, we focus on results for US$ returns, although local currency returns are reported.The results indicate substantial differences in factor sensitivity and risk between the cointegrated and independent portfolios although benefits from risk sensitivity may be offset by lower aggregate performance. We re-examine the results for different time periods and for sector-specific company indices and, finally, examine the results for companies focussed in global financial centres. Differences in the results shed light on the sources of integration and systematic risk.