MODERN PORTFOLIO THEORY & REAL ESTATE INVESTMENT DIVERSIFICATION : A CASE STUDY OF HONG KONG

Abstract

Naive diversification is proving to be a "primitive" approach as property investments analyst and property investors are resorting to the more scientific approach provided by the Modern Portfolio Theory to analyse the risk-return characteristics of portfolios. However, owing to the heterogeneous nature of real estate assets, there is a controversy as to whether investors should classify real estates by types or by their geographical locations. Therefore, this study is principally aimed at evaluating the usefulness of sectoral and regional diversification on the basis of a case study of Hong Kong property market. After a literature review and two empirical analyses of ex-post return data (from January 1984-April 1995) for every sector (namely office, retail, residential and industrial) and three locations (namely Central, Wanchai/Causeway Bay and Tsim Sha Tsui), this study came to one important conclusion. Sectoral diversification is more effective in maximising wealth at a given level of risk as the correlation between the sectors are much lower than for regional diversification.