Role of farm real estate in a globally diversified asset portfolio

Published date27 April 2010
DOIhttps://doi.org/10.1108/14635781011048858
Date27 April 2010
Pages198-220
AuthorGilbert Nartea,Chris Eves
Subject MatterProperty management & built environment
Role of farm real estate in a
globally diversified asset portfolio
Gilbert Nartea
Department of Accounting, Economics and Finance, Faculty of Commerce,
Lincoln University, Christchurch, New Zealand, and
Chris Eves
School of Urban Development, Faculty of Built Environment and Engineering,
Queensland University of Technology, Brisbane, Australia
Abstract
Purpose – This paper seeks to examine the benefits of further diversifying a global portfolio of
financial assets with New Zealand farm real estate (FRE).
Design/methodology/approach – The paper compares efficient sets generated with and without
FRE using portfolio theory.
Findings – The results show that given the predominantly negative correlation between FRE and
financial assets, the risk-return tradeoffs of portfolios of financial assets can be improved significantly.
The diversification benefits measured in terms of risk reduction, return enhancement, and
improvement in the Sharpe performance ratios are robust under a number of FRE risk-return scenarios
as well as under high and low inflationary periods. Using five and ten-year rolling periods it also finds
that FRE is a consistent part of risk efficient portfolios. Consistent with the results reported in Lee and
Stevenson, for the UK real estate the risk reduction benefits of diversifying with FRE are larger than
the risk enhancement benefits.
Practical implications – The results suggest that FRE takes on a consistent role of risk-reducer
rather than a return-enhancer in a globally diversified portfolio. FRE appears to deserve more serious
consideration by investment practitioners that it has been accorded in the past.
Originality/value – The study examines the role of direct real estate in a globally diversified
portfolio of financial assets.
Keywords Diversification,Farms, Real estate, New Zealand, Portfoliotheory
Paper type Research paper
1. Introduction
The poor performance of global stock markets in recent years has ignited renewed
interest in alternative investments to enhance return and reduce risk (Lee and
Stevenson, 2006) through effective diversification. With increased globalisation one
obvious avenue is international equity diversification, the benefits of which have been
well documented (see for example, Levy and Sarnat, 1970; Harvey, 1991; Li et al., 2003;
Meyer and Rose, 2003; Fletcher and Marshall, 2005; Phengpis and Swanson, 2004).
However, with increased globalisation comes increased economic and financial
integration leading to increased positive correlations among international equity
markets with the consequent decline in the benefits from international diversification
(Kearney and Lucey, 2004).
Real estate returns on the other hand has traditionally been shown to have a low
correlation with financial assets and are therefore regarded as excellent vehicles for
diversification (see Seiler et al., 1999 for an excellent review). Farm real estate (FRE) in
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
JPIF
28,3
198
Received December 2009
Accepted March 2010
Journal of Property Investment &
Finance
Vol. 28 No. 3, 2010
pp. 198-220
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781011048858
particular appear to have a consistently low correlation with returns from financial
assets with several North American studies suggesting the desirability of adding farm
real estate (FRE) to a mixed portfolio of financial assets (Barry, 1980; Kaplan, 1985;
Young and Barry, 1987; Moss et al., 1987; Lins et al., 1992; Painter, 2000; Eves and
Newell, 2007). However few have tested the robustness of these benefits.
Barry (1980) finds that US farmland has low systematic risk relative to other assets,
and is therefore a good candidate for risk reduction in well-diversified portfolios. Kaplan
(1985) also argues that US farmland’s high return and low correlation with US stocks and
bonds makes it an ideal asset for diversification. Young and Barry (1987) find Illinois
farmland to be negatively correlated with US stocks, corporate, government, and
municipal bonds as well as T-bills and certificates of deposit. Using mean-variance (EV)
analysis they show that Illinois farmers could reduce the relative variability of their
farm’s rate of return some 15 to 25 per cent by allocating up to 25 per cent of their
investment portfolio in financial assets. Moss et al. (1987) likewise find that aggregate US
farmland is negatively correlated with corporate and government bonds and T-bills and
moderatelypositivelycorrelatedwithUSstocks.UsingEVanalysistheyform
risk-efficient portfolios that contained 30 to 68 per cent farmland. Lins et al. (1992) also
used EV analysis to investigate the effect of adding US farmland and international stocks
to a portfolio of US stocks, bonds and business real estate. They find that, portfolio
performance could be enhanced, by including US farmland in the mix. In Canada, Painter
(2000) investigates the benefits of adding Saskatchewan farmland to a portfolio of
Canadian and international stocks and Canadian T-bills and long-term bonds. He finds
that Saskatchewan farmland is negatively correlated with all financial assets considered
in the study and is part of the efficient set for medium and high-risk portfolios.
In New Zealand Nartea and Dhungana (1998) report that NZ dairy farm returns are
negatively correlated with NZ bond yields and weakly positively correlated with NZ
share returns and suggest that farmers look towards diversifying into financial assets.
Nartea and Pellegrino (1999) use EV analysis to investigate the benefits of diversifying
a sheep and beef farm with investments in New Zealand shares. They document a
negative correlation between farmland and share returns over the period 1966 to 1996
and report that a portfolio consisting of 16 to 25 per cent shares and 75 to 84 per cent
farmland could reduce risk by as much as 20 per cent as compared with investing in
farmland alone. Updating Nartea and Pellegrino’s (1999) data set, and incorporating
investor risk preferences, Nartea and Webster (2008) use data from 1966-2003 and
report that NZ farmers with high degrees of risk aversion would gain utility by adding
NZ financial assets to their portfolio dominated by farm real estate. In a related study,
Nartea and Eves (2008) using data from 1995-2005 found that adding direct real estate,
in particular retail property and farm real estate, to a portfolio of NZ financial assets
provided significant return enhancement and risk reduction benefits that are robust
even when real estate return variance is increased six-fold or when real estate returns
are reduced by 20 per cent, suggesting that real estate can reasonably be expected to be
a consistent part of risk efficient portfolios.
In spite of these findings anecdotal evidence suggests that investment practitioners
allocate a negligible portion of their portfolios to farm real estate. One reason for this
could be the suggestion that real estate form part of mixed asset portfolios in
theoretical studies due to the understatement of real estate risk and/or due to inflation
(Webb and Rubens, 1987; Michaud, 1989; Fisher et al., 1994; Corgel and deRoos, 1999).
Role of farm
real estate
199

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