Forecasting EREIT Returns

Forecasting EREIT Returns

Camilo Serrano, Martin Hoesli,
Volume: 13
Issue Number: 4
Year: 2007
Publication: Journal of Real Estate Portfolio Management

Executive Summary. This paper analyzes the role played by financial assets, direct real estate, and the Fama and French (1993) factors in explaining equity real estate investment trust (EREIT) returns and examines the usefulness of these variables in forecasting returns. Four models are analyzed and their predictive potential is assessed by comparing three forecasting methods: time varying coefficient (TVC) regressions, vector autoregressive (VAR) systems, and neural networks models. Trading strategies on these forecasts are compared to a passive buy-and-hold strategy. The results show that EREIT returns are better explained by models including the Fama and French factors. The VAR forecasts are better than the TVC forecasts, but the best predictions are obtained with neural networks and especially when they are applied to the model using stock, bond, real estate, size, and book-to-market factors.

Correlation, Return Gaps and the Benefits of Diversification

Correlation, Return Gaps and the Benefits of Diversification

Statman, Meir and Scheid, Jonathan, "Correlation, Return Gaps and the Benefits of Diversification" (November 2007).

Abstract:

Correlation is the common indicator for the benefits of diversification, but it is not a good indicator. This is for two reasons. First, the benefits of diversification depend not only on the correlations between returns but also on the standard deviations of returns. Second, correlation does not provide an intuitive measure of the benefits of diversification. Return gaps are better indicators. Return gaps are the difference between the returns of two assets or between two portfolios.

For example, the estimated 12-month return gap between the S&P 500 Index and the Russell 2000 Index and during February 2002 – January 2007 was 8.90%, implying that investors who concentrated their portfolios in one index or the other should have expected to lead or lag investors who diversified between the two in equal proportions by 4.45%. The realized 12-month return gaps ranged from 0.1% to 28.7%. It is hard to deduce these figure intuitively from the relatively high 0.82 correlation between the two. Similarly, it is hard to deduce intuitively from the relatively high 0.86 correlation between the S&P 500 and EAFE Indexes that their estimated 12-month return gap was 6.86% and their realized 12-month return gaps ranged from 1.8% to 23.0%. Moreover, the figures belie any claim that these assets' risk-reduction benefits have largely vanished.

Beta Based Asset Allocation: Simplicity and Transparancy

Beta Based Asset Allocation: Simplicity and Transparancy

By P. Brett Hammond, TIAA-CREF Institute (Winter 2007)

This is a companion piece to a paper titled Reverse Asset Allocation: Alternatives at the Core, written in the second quarter of 2007. As discussed in that paper, the challenges and potential benefits of alternative assets include portfolio instability and counterintuitive results on the one hand, and superior return and risk expectations on the other — characteristics that become strikingly evident through asset allocation exercises involving alternatives

International Price and Earnings Momentum

International Price and Earnings Momentum

Leippold, Markus and Lohre, Harald, (March 4, 2008)

Abstract:

We find that price and earnings momentum are pervasive features of developed equity markets when controlling for multiple testing issues. Having ruled out data snooping as possible explanation for both phenomena, the evidence becomes even more startling. Recently, Chordia and Shivakumar (2006) argue that U.S. price momentum is subsumed by earnings momentum. We replicate their empirical finding for the U.S. and show that it does carry over to Europe on an aggregate level, but it does not apply to each and every European country. While the above explanation seems to be confined to certain time periods, earnings momentum nevertheless appears to be a crucial factor in explaining the price momentum anomaly in many developed markets. Since we cannot establish a decent relation between the earnings momentum phenomenon and macroeconomic risks we suspect a behavioral-based explanation to be at work. Narrowing the search for such a behavioral explanation we provide evidence that the anomaly is most likely not related to dispersion in analysts' earnings forecast.

S&P Global Index Review

S&P Global Index Review

The Global Index Review is designed for money managers and derivative traders to help them assess the performance and correlations of the S&P indices against other popular indices. Published quarterly, the Global Index Review provides a graphic summary of each Standard & Poor’s equity index and compares performance, where appropriate, against other leading indices around the world. It includes data and comparative analysis on the S&P Global 1200, S&P/Citigroup Indices, regional components, as well as sector, style and domestic indices with indices from MSCI, FTSE, Russell, Wilshire, Dow Jones STOXX, and Nikkei. The Global Index Review offers comparative performance, portfolio characteristics, sector weights, tracking statistics and correlations. For easy referencing, this publication is broken into regional chapters
including:

- Global Indices
- U.S. Indices
- European Indices
- Japanese Indices
- Canadian Indices
- Australian Indices
- Asia and Latin America
- Alternative Indices

S&P Alternate Assets Report

S&P Alternate Assets Report

The quarterly S&P Global Alternative Assets Report provides institutional investors with comprehensive performance analysis across a number of alternative asset classes.

Global alternative assets included in this issue:

S&P Listed Private Equity
S&P Global Infrastructure
S&P MLP
S&P U.S. Preferred Stock
S&P/TSX Preferred Share
S&P Global Timber & Forestry
S&P Select Frontier
S&P Global Property 40

Performance of Canadian E-REITs

Performance of Canadian E-REITs

Lawrence Kryzanowski
Finance Department, John Molson School of Business, Concordia University,
1455 de Maisonneuve Blvd. West, Montreal, Quebec, Canada, H3G 1M8
E-mail: lkryzan@alcor.concordia.ca.
Margarita Tcherednitchenko
Finance Department, John Molson School of Business, Concordia University,
1455 de Maisonneuve Blvd. West, Montreal, Quebec, Canada, H3G 1M8
E-mail: cheritka@yahoo.com

INTERNATIONAL REAL ESTATE REVIEW
2007 Vol. 10 No. 2: pp. 1 - 22

The return performance and factor sensitivities of Canadian equity real estate investment trusts (E-REITs) are examined. Today, typical and average Canadian E-REIT IPOs are correctly priced based on first-day and subsequent short-run returns. The overpricing evident earlier in the 1993-96 period for typical and average E-REIT IPOs has corrected. E-REITs are equity investments with about one-half the market risk, and greater sensitivity to interest-rate changes, than the S&P/TSX Composite Index. E-REITs outperformed the S&P/TSX Composite over the 1996-2004 period on a return, risk, and market- and/or risk-adjusted basis. Thus, E-REITs provided material diversification benefits with no sacrifice in return, when added to a common stock portfolio during the studied period.

Does the Composition of the Market Portfolio Matter for Performance Rankings of Post-1986 Equity REITs?

Does the Composition of the Market Portfolio Matter for Performance Rankings of Post-1986 Equity REITs?

Justin D. Benefield, Randy I. Anderson , Leonard V. Zumpano, Journal of Real Estate Portfolio Management, Volume 13, no. 3.

Executive Summary. Real estate investment trust (REIT) research indicates that performance rankings do not differ between market proxies containing real estate and the Standard and Poor’s 500, while mutual fund research shows that the proxy chosen significantly impacts performance rankings. Previous REIT performance ranking studies used rather obscure market indices, and only included time periods prior to the Tax Reform Act of 1986. Common market proxies are used to address whether the proxy chosen matters in REIT performance studies. Performance rankings utilize standard singlefactor methodologies and, where possible, their multifactor equivalents. Across all comparisons, results indicate that performance rankings of post-1986 equity REITs are insensitive to the market proxy chosen.

Do REITs Behave More Like Real Estate Now?

Do REITs Behave More Like Real Estate Now?

Tsai, I-Chun, Chen, Ming-Chi and Sing, Tien Foo, (November 2007)

Abstract

This paper applies the Time Varying Coefficient (TVC) approach to examine the systematic risks of the National Association of Real Estate Investment Trusts (NAREIT) return index using the Capital Asset Pricing Model (CAPM) framework. We found that the systematic risk of Real Estate Investment Trusts (REITs) is time varying with the REIT-beta declining over time. The declining beta reflects the greater acceptance of REITs as an important asset class in investors' portfolios. Investors would accept a lower risk premium because investors are better able to price the underlying assets the longer REIT assets are securitized. The results support the view that the real estate securities behave more like real estate and less like the general stock market.

Private Equity and Strategic Asset Allocation

Private Equity and Strategic Asset Allocation

Tom Idzorek, CFA, V.P., Director of Research & Product Development, Ibbotsen, October 31, 2007

Executive Summary

This paper studies the role of U.S. Private Equity and Non-U.S. Private Equity in a strategic asset allocation. There is relatively little guidance in the literature on how much investors should allocate to private equity in a strategic asset allocation setting because of 1) confusion between the private equity asset class and private equity funds and 2) considerable debate over historical returns. Private equity is both an asset class and an investment strategy. Distinguishing between the private equity asset class and the private equity investment strategy can be confusing and creates challenges for asset allocators. Ideally, one could invest in a basket of all private corporations in which the weights of the companies in the basket are based on their true values. Such a basket would be a true representation of the private equity asset class. When investors make an allocation to private equity, it is not a passive investment in the basket of all private companies that form the private equity asset class. Rather, for most investors, the allocation to private equity is an investment in a skill-based strategy in which the two primary sub-strategies are leveraged buyouts and venture capital. The fragmented structure of the private equity market is such that private equity investors cannot fully-diversify away from private company specific risk; thus, all private equity investments are a mixture of systematic risk exposure to the private equity asset class and to private company specific risk. Securitization is changing the private equity asset class and, over time, what was once an alpha strategy will become a traditional beta asset class. In this paper, we use two new indices to proxy the private
equity asset class – the Red Rocks Listed Private Equity IndexSM (LPE IndexSM) for U.S. private equity and the Red Rocks International Listed Private Equity IndexSM (International LPE IndexSM) for non-U.S. private equity. The listed private equity indices may more accurately reflect the performance characteristics, especially the volatility, of the private equity asset class than appraisal-based private equity indices. In a series of historical optimizations, we find that including U.S. Private Equity in the opportunity set would have dramatically improved the risk and return characteristics over the past 10 year period. From the beginning of 1997 to the end of 2006, U.S. Private Equity and Non-U.S. Private Equity were the best performing asset classes in our opportunity set, although the performance of the private equity proxies appears to be highly sensitive to the weighting scheme of the proxies. This sensitivity highlights that all private equity investments still contain a high level of specific risk. Over time, we think securitization will reduce the amount of specific risk associated with private equity portfolios. In a forward-looking optimization using a set of returns based on a global implementation of the CAPM, the asset allocations with a standard deviation below 19% were only slightly improved by including private equity in the opportunity set. The benefit of including private equity in the opportunity set is most significant for higher risk, equity-centric asset allocations. Finally, listed private equity will make it possible to apply tactical asset allocations to the asset class.

Portfolio Construction for Taxable Investors

Portfolio Construction for Taxable Investors

Scott J. Donaldson, CFA,CFP, and Frank A. Ambrosio, CFA, Vanguard Investment Counseling & Research (2007)

Executive summary. Most investment portfolios are designed to meet a specific future financial need—either a single goal or a multifaceted set of objectives. To reach those goals and objectives, a disciplined method of portfolio construction must be established that balances the potential risks and returns of various types of investments. This paper reviews various aspects of our research involving five major investment decisions that need to be made, in successive order, in the portfolio construction process. The decisions are:

Asset allocation—Choosing asset-class weights: equities, fixed income, cash, and so on.

Sub-asset allocation—Choosing investments within an asset class, such as U.S. or international equities; or large-, mid-, or small-capitalization equities.

Active and/or passive allocations—Choosing indexed and/or actively managed assets.

Asset location—Deciding on the placement of investments in taxable and/or tax-advantaged accounts.

Manager selection—Choosing individual managers, funds, or securities to fill allocations.

The top-down order in which these decisions are made is important in establishing a well-constructed portfolio. Many investors use a bottom-up approach, placing more emphasis on manager/security selection or sub-asset allocation (based on an investment’s recent returns) than on asset allocation, the most important portfolio decision. However, in using a bottom-up approach, the selection of the investments—potentially the more uncertain part of portfolio construction—would then determine the more important part—the overall asset allocation. After deciding the asset allocation of the portfolio, it is important to keep in mind that broad diversification, with exposure to all parts of the stock and bond markets, is a powerful strategy for managing portfolio risk. Diversification across asset classes reduces a portfolio’s exposure to the risks common to an entire asset class. Diversification within asset classes reduces a portfolio’s exposure to the risks associated with a particular company, sector, or market. This diversification can be achieved through index and/or actively managed investment strategies. The decision to purchase certain investments within either tax-advantaged and/or taxable accounts, known as asset location, is a valuable tool to increase potential after-tax returns. This can be achieved by placing tax efficient assets in taxable accounts and tax inefficient assets in tax-advantaged accounts. Selecting specific investments to represent the various market segments should come last. A common error in portfolio construction is that of choosing specific investments that may appear to be worthwhile individually, but make little sense when combined in a portfolio. In the end, this collection of investments does not necessarily form a coherent asset allocation or sub-asset allocation that matches the investor’s objectives and risk tolerance.

Economic Integration and Mature Portfolios

Economic Integration and Mature Portfolios

Christelis, Dimitris, Georgarakos, Dimitris and Haliassos, Michael, (January 31, 2008). Center for Financial Studies, Forthcoming

Abstract:

This paper documents and studies sources of international differences in participation and holdings in stocks, private businesses, and homes among households aged 50 in the US, England, and eleven continental European countries, using new internationally comparable, household-level data. With greater integration of asset and labor markets and policies, households of given characteristics should be holding more similar portfolios for old age. We decompose observed differences across the Atlantic, within the US, and within Europe into those arising from differences: a) in the distribution of characteristics and b) in the influence of given characteristics. We find that US households are generally more likely to own these assets than their European counterparts. However, European asset owners tend to hold smaller real, PPP-adjusted amounts in stocks and larger in private businesses and primary residence than US owners at comparable points in the distribution of holdings, even controlling for differences in configuration of characteristics. Differences in characteristics often play minimal or no role. Differences in market conditions are much more pronounced among European countries than among US regions, suggesting significant potential for further integration.

Do Reits Outperform Stocks and Fixed-Income Assets? New Evidence from Mean-Variance and Stochastic Dominance Approaches

Do Reits Outperform Stocks and Fixed-Income Assets? New Evidence from Mean-Variance and Stochastic Dominance Approaches

Chiang, Thomas Chinan, Lean, Hooi Hooi and Wong, Wing-Keung, (June 1, 2007)

Abstract:

This paper re-examines the performance of REITs, stocks, and fixed-income assets based on the preferences of risk-averse and risk-seeking investors using mean-variance and stochastic dominance approaches. Our findings indicate no first-order stochastic dominance and no arbitrage opportunity among these assets. However, our stochastic dominance results reveal that in order to maximize their expected utility, the risk-averse prefer fixed-income assets over real estate, which, in turn, is preferable to stocks. On the other hand, to maximize their expected utility, all risk-seeking investors would prefer to invest in stocks than in real estate, but real estate, in turn,is preferable to fixed-income assets.

Opportunistic Rebalancing: A New Paradigm for Wealth Managers

Opportunistic Rebalancing: A New Paradigm for Wealth Managers

Gobind Daryanani CFP®, Ph.D., FPA Journal (January, 2008)

Executive Summary

• Wealth managers traditionally rebalance portfolios quarterly or annually to control risk due to asset class drifts. This paper proposes a new paradigm for planners: rebalance less frequently, but look more frequently to find the best opportunities for rebalancing.
• The proposed approach, called opportunistic rebalancing, not only controls portfolio drift, but also provides significant return improvements by capturing buy-low/sell-high opportunities as asset classes sporadically drift relative to each other.
• The paper studies a wide range of market conditions to show that rebalancing return benefits can be more than doubled compared with the traditional annual rebalancing.
• These additional benefits, attributed to transient momentum and mean reversion effects, occur sporadically in time and can only be captured by monitoring portfolios frequently.
• The studies suggest these practical guidelines: (1) use wider rebalance bands, (2) evaluate client portfolios biweekly, (3) only rebalance asset classes that are out of balance—not classes that are in balance, and (4) increase the number of uncorrelated classes used in portfolios.
• The studies show that trading costs and tax deferral are small compared with rebalance benefits.
• Opportunistic rebalancing has already been adopted by a number of leading wealth management firms across the country.