Effects of portfolio diversification on property investment company stock prices: 1983‐1994
| Date | 01 August 2001 |
| DOI | https://doi.org/10.1108/EUM0000000005792 |
| Pages | 390-411 |
| Published date | 01 August 2001 |
| Author | Tien Foo Sing,Kanak Patel |
| Subject Matter | Property management & built environment |
JPIF
19,4
390
Journal of Property Investment &
Finance, Vol. 19 No. 4, 2001,
pp. 390-411. #MCB University
Press, 1463-578X
Revised October 2000,
May 2001
ACADEMIC PAPERS
Effects of portfolio
diversification on property
investment company stock
prices: 1983-1994
Tien Foo Sing
Department of Real Estate, School of Design and Environment, National
University of Singapore, Singapore
Kanak Patel
Department of Land Economy, University of Cambridge, Cambridge, UK
Keywords Property markets, Stock markets, Assets, Diversification, Cointegration
Abstract Analyses the diversification effects of the portfolio holdings of ten selected listed
property investment companies on the co-movement of the stock prices for an 11-year period from
1983 to 1994. The long-term common trends in the sample securitized property companies are
tested using the bivariate and the Johansen's multivariate cointegration methodologies. The
empirical evidence does not reject the hypothesis that prediction of the price variation of one stock
based on the change in the price of another comparable stock is possible in the long term. Also, the
price convergence process was not dependent on whether two companies are practising the same
diversification and/or specialisation policies. However, there is evidence that companies with large
portfolio holdings can influence the stock prices of property companies with smaller portfolio
holdings. This implies that arbitraging the small stocks by reading the price movement of the large
firms could give possible abnormal returns to the investor.
1. Introduction
Diversifications by geographic region and property type are the common
portfolio strategies adopted by institutional property investors and property
investment funds such as the equity real estate investment trusts (REITs).
Gyourko and Nelling (1996) examined the effects of these two strategies on the
market-based measures of diversification and systematic risk. Two interesting
findings were reported in their empirical study. First, they found no evidence of
Spearman rank correlation between the market-based equity REIT
diversification measures and the diversification strategies either by property
type, by geographic or by broad economic regions. The results, however,
showed significant firm size effects on the effectiveness of diversification
strategy. Second, systematic risks of equity REITs varied with respect to the
type of property in their portfolio holdings, but the systematic risk variations
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The authors wish to thank Professor Dean Paxson, Manchester Business School, and other
referees for their kind comments on the earlier draft.
Academic
papers: Portfolio
diversification
391
were not dependent on the geographical dispersion of the properties in the
firm's portfolio.
The first finding of Gyourko and Nelling (1996) suggests that there are some
forms of naõÈve diversification adopted by fund managers. The heterogeneity of
the company's property holdings in terms of property type, geographical or
economic regions, is irrelevant to the market-based measures of diversification.
In other words, the diversification effects of securitized property stocks with
heterogeneous property portfolios by types and/or by geographical and
economic regions are indifferent from those adopting naõÈve portfolio strategies.
It implies some degrees of segmentation between the securitized and
unsecuritized property markets, a proposition that is consistent with the earlier
findings by Liu et al. (1990), Wilson et al. (1996) and Ong (1995). Institutional
investors would no longer be able to effectively replicate the payoff
characteristics of the unsecuritized property market by holding securitized
property assets. Therefore, securitized property, or the equivalent of equity real
estate investment trust (EREIT) in the USA, is no longer a good proxy of the
unsecuritised (direct) property investment as claimed by Giliberto (1990) and
Martin and Cook (1991).
In the second finding, Gyourko and Nelling (1996) observed an empirically
significant relationship between the systematic risk and the type of property
holdings of the EREITs. Their results showed that the betas of EREITs with
heavy retail concentration in their portfolio were 40 per cent higher than those
of the industrial and warehouse related EREITs. As the systematic risk is
higher in retail EREITs vis-aÁ-vis industrial EREITs, it would not be in the best
interests of investors to hold EREITs that have high exposure in the retail
market, unless it is justified by higher long-term returns from the retail
EREITs. These observations were not quite in line with the ``irrelevance of
diversification strategy'' hypothesis postulated in their first finding. Since we
could not expect risk-averse fund managers to exclude retail property
wholesale from the portfolio of EREITs, diversification at least by property
type still matters. The hypothesis that the type of property holdings of the
EREITs has no significant bearing on the diversification decision of the
investors could not thus be rejected outright.
Based on Gyourko and Nelling's (1996) findings, there are two important
implications of how portfolio diversification strategies adopted by firms, either
by property type or geographic regions, affect the long-term performance of
their respective stocks. Two research hypotheses are evolved from their study.
If the ``irrelevance of diversification'' hypothesis is valid, we should reject the
null hypothesis, which suggests that:
H1
0
. Prices of securitized property companies will converge in the long run
if and only if the companies have comparable portfolio holdings by
property type or by geographic region.
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