Diversification Effects of Indirect Real Estate In A Mixed Asset Portfolio - The Malaysia Experience

"The high percentage of world investable wealth held in property coupled with price volatility and poor returns in the equity trading market have make investors turn to property for higher return. With the introduction of Modern Portfolio Theory, portfolio investments have become the norm whereby investors seek to achieve higher portfolio returns at a given risk level or lowest risk at a given level of return. The intent of this study is to present the benefits of including indirect real estate in a mixed asset portfolio of stocks, bonds and cash using the Malaysian data. Indirect real estate is proxy by REITs and property share. Different return interval (monthly, quarterly, semiannually and annually) for two study period (12/1995-12/2007- whole study period; 12/1998-12/2007- post crisis period) are used to analyze the benefits of including these two indirect real estate in a portfolio. First, by applying the optimal portfolio without the indirect real estate, and then, with the inclusion of indirect real estate for both the study periods. Low correlation between assets class is one factor which determines the attractiveness of an asset for inclusion in a mixed asset portfolio. The mean-variance criterion shall be applied in which investors are assumed to try to achieve highest return of the portfolio based on average returns and standard deviations as measure of risk. Optimal portfolio returns is computed based on equal investments of asset class, highest portfolio returns, lowest portfolio returns and highest Sharpe ratio. Although earlier international and local studies suggested that REITs provide a good diversification benefits in a portfolio, the findings showed that Malaysian REITs is still far from being attractive compared to stocks, bonds and cash. Property share as expected have very high correlation and underperformed stock and are more volatile making it a less attractive investment option. The conclusion drawn is that indirect real estate in Malaysia does not provide diversification benefits. REITs may be considered for inclusion during good economic period, but not otherwise. Historical data computed for analysis should not be in the longer period as it erodes the effectiveness of the computation. A shorter period of analysis allows changing investment environment to be taken into consideration.""