THE ROLE OF REAL ESTATE IN A MULTI ASSET PORTFOLIO

Abstract

Modern Portfolio Theory has proposed that diversification across assets which are less than perfectly correlated will reduce the risk of the overall portfolio. In Singapore, investors have applied the theory and diversified their portfolios by investing in different sectors of common stocks, or government bonds with different maturity periods. The purpose of this study is to examine the potential of real estate investment as a means of spreading the risk in multi-asset portfolios which include common stocks and government bonds. It is found that historically, real estate has performed better than both common stocks and government bonds, compensating investors with higher returns for the same level of risk undertaken. At the same time, its negative correlation with government bonds and weak positive correlation with common stocks also indicates that investment in real estate does provide diversification opportunities for investors. The asset allocation results showed that for investors who have a short term outlook on their investment, real estate would constitute over 60 percent of the asset mix in high return, high risk multi-asset portfolios. In low risk and return multi-asset portfolios, government bond is the dominant form of investment, with real estate being the second most substantial investment and only minimal investment in common stocks. Similarly, for investors whose holding period is longer, a sizeable investment in real estate would provide risk diversification benefits. However, investors should be cautioned that the amount to be allocated to real estate and the gains from it depends on their risk aversion, ability to replicate the diversity of portfolio in the real estate index and timing of the investment.