The investigation of the role of real estate in a mixed-asset portfolio within the South African Pension Fund Industry

The objectives of this research are to assess the returns, risks and correlation ofa mixed-asset portfolio, establish the role of real estate in a mixed-assetportfolio and suggest an appropriate real estate allocation in the South Africanpension fund industry. The issue of low real estate allocation has been a subjectof interest to practitioners and academics, both locally and internationally,despite the diversification benefit that real estate provides in a mixed-assetportfolio.A statistical approach was considered most the appropriate tool for analyzingreturns. Solver optimizer in the excel spreadsheet package was used togenerate efficient frontiers and the associated values of portfolios. Real estateprovided a lower return of 1.25% and a lower standard deviation of 4.90%compared to equities with a return of 1.39% and the highest standard deviationof 6.23%, whilst bonds provided the best risk-return trade off, with a return of1.42% and the lowest standard deviation of 2.64%. An equally -weightedportfolio consisting of bonds and stocks and a portfolio consisting bonds, stocksand real estate was simulated. The equally -weighted portfolio of bonds andstocks provides a return of 1.41% and a standard deviation of 3.76%. Theminimum variance with bias to bonds provides a higher return of 1.42% at alower level of risk of 2.62%. The equally -weighted portfolio consisting of bonds,stocks and real estate provides a return of 1.35%, with a lower risk of 3.49%.The minimum variance with bias to bonds provides almost the same return of1.40% at a lower level of risk of 2.54% compared to the bond and shareportfolio.The Chi-Square statistical tool was used to test the diversification benefit of realestate. It can be concluded that the standard deviation of the portfolio withproperty is close enough to the standard deviation without property of 3.76%and cannot statistically say that it is different given the 5% level of significance.The Sharpe ratio was used to test the favourable risk adjusted returns offeredby real estate. It concluded that property provides favourable risk adjustedreturns and diversification benefits, as illustrated with the increasing portfolio return from 7.44% to 8.66% on Sharpe ratio basis and standard deviation of theportfolio decreasing from 3.76% to 2.54%.The literature review generally supported the view that real estate has a role in amixed-asset portfolio. Research topics such as securitized versus unsecuritizedreal estate, real estate allocation and diversification, returns and risk, inflationhedging, modern portfolio theory and the efficient -frontier were analysed andrelated to the research report.The empirical analysis supports the hypothesis that real estate providesdiversification benefits. The property cycle is positive and it is supported bypositive property fundamentals like (vacancies are at lowest levels,capitalisation rates are strengthening, the property cycle is turning positive anda stable interest rate environment). The positive property fundamentals will leadto earnings growth.An allocation of between 10% based on the lower end of the minimum varianceand 15% based on the lower end of the risk/return ratio is recommended for amixed-asset portfolio.