DIVERSIFICATION BENEFITS OF EUROPEAN REAL ESTATE SECURITIES IN DOMESTIC AND INTERNATIONAL PORTFOLIOS

Abstract

This research examines the role of European real estate securities traded in Austria, Belgium, Finland, France, Germany, Italy, Spain, Sweden, Switzerland, United Kingdom and United States in domestic mixed-asset and international investment portfolios.

By computing the risk-adjusted performance, correlations and Markowitz portfolio theory, the objective is to assess whether European real estate securities enhance portfolio performance. In addition, local and U.S dollars are used to examine whether currency has negated the diversification benefits over the study period. This research spans over a 10-year period beginning from May 1999 to April 2009. In order to assess the stability of correlations during varying market conditions, two sub-periods from 1999 to 2004 and 2004 to 2009 are also adopted in the research.

The findings show that most of the European and U.S real estate securities have outperformed the other asset classes over the entire study period. However, it is noted that the risk-adjusted performance of real estate securities markets is not ideal when compared to cash and bonds. Most of the European real estate securities tend to have more superior risk-adjusted performance than common equities in the long-run.

Unlike the correlations of real estate securities with cash and bonds, the correlations of the real estate securities and common stocks have grown stronger in the second sub-period as compared to the first sub-period. This is likely due to the higher inter-regional correlation caused by the sub-prime crisis. As such, diversification benefits of property stocks in the domestic mixed-asset portfolios have been greatly reduced.

The results have also shown that despite the increasing global financial market integration, the European real estate securities can still offer international diversification benefits, even though the diversification benefits of property stocks during the period of high market volatility are not pronounced.