Testing the statistical significance of sector and regional diversification
| Date | 01 October 2005 |
| DOI | https://doi.org/10.1108/14635780510616007 |
| Published date | 01 October 2005 |
| Pages | 394-411 |
| Author | Stephen Lee,Simon Stevenson |
| Subject Matter | Property management & built environment |
Testing the statistical
significance of sector and regional
diversification
Stephen Lee
Centre for Real Estate Research (CRER), School of Business, The University of
Reading, Reading, UK
Simon Stevenson
Cass Business School, City University, London, UK, and
University College Dublin, Dublin, Ireland
Abstract
Purpose – The question as to whether it is better to diversify a real estate portfolio within a property
type across the regions or within a region across the property types is one of continuing interest for
academics and practitioners alike. However, this study is somewhat different from the usual
sector/regional analysis in that this study is designed to investigate whether a real estate fund
manager can obtain a statistically significant improvement in risk/return performance from extending
out of a London based portfolio into firstly the rest of the South East of England and then into the
remainder of the UK, or whether the manger would be better off staying within London and
diversifying across the various property types.
Design/methodology/approach – In order to examine these issues we form a number of portfolios
that can be directly compared to a number of benchmark portfolios, as well as to each other. Then
using the statistical tests developed by Gibbons et al. and Jobson and Korkie, we investigate whether
the benefits that accrue from the differing diversification strategies are statistically significant or not.
Findings – The results show that staying within only one sector and one region (London) is
undesirable in terms of risk and return compared with all three benchmark portfolios considered here.
Secondly diversification on a naı
¨ve basis, or in an optimal fashion, leads to significant improvements
in performance, irrespective of whether it is across different property types within London or within
the same sector across the regions. Finally the results indicate that staying within London and
diversifying across the various property types may offer performance comparable with regional
diversification, although this conclusion largely depends on the time period and the fund manager’s
ability to diversify efficiently.
Originality/value – The results suggest that diversification almost always offers increased
performance. Indeed a little diversification can quickly lead to levels of performance that is superior to
number of benchmarks as well as performance insignificantly different from that of the most
diversified portfolio that could be constructed! Consequently fund managers should be encouraged to
diversify, be it across the regions or across the sectors of the UK.
Keywords Real estate, Diversification, Property,United Kingdom
Paper type Research paper
1. Introduction
In deciding to expand a real estate portfolio within a domestic market a key point of
interest is the relatively benefits of sector (across property types within a region)
versus regional (across the regions within a property type) diversification. A related
The Emerald Research Register for this journal is available at The current issue and full text archive of this journal is available at
www.emeraldinsight.com/researchregister www.emeraldinsight.com/1463-578X.htm
JPIF
23,5
394
Received May 2005
Accepted October 2005
Journal of Property Investment &
Finance
Vol. 23 No. 5, 2005
pp. 394-411
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635780510616007
question is whether overall diversification is to be preferred. However, the UK market
presents a particular problem when considering sector and regional div ersification.
The investment institutions, insurance companies and pension funds, in the UK,
together with foreign investors have a bias towards London, especially the city office
market.
A number of reasons exist for this focus of investment in London by UK
institutions. First there is more information on the real estate market of London,
especially so for city offices, as London is the most researched region in the UK and
Europe. Second in terms of the stock of offices London accounts for the majority of the
total office space in the UK. Third although the speed and costs of transaction varies
enormously from one property type to another and across properties of differing
lot-sizes, London typically offers the greatest speed of execution, for properties of a
similar lot-size, across all property sectors McNamara (1999). Consequently for most
institutional investors in the UK property in London provides an easy entry into direct
real estate investment market. As a result whilst the bias towards London has declined
over time, due to the server market collapse of offices in London market in the early
1990s, at the end of 1999 the UK institutional investors still held over one-third of their
investments in the London region, despite factors such as the server market collapse of
offices in London market in the early 1990’s.
Similar arguments can be made to explain overseas investor interest in London.
Not only is London the most researched, potentially most liquid and contains a
sufficient stock of the right quality the but London office market is the most
mature market in Europe (Keogh and D’Arcy, 1994) and is on a par with those
found in the USA (Gordon, 2000). Alongside this, property in the UK shows
relatively longer lease lengths, a more the favourable lease-structure and relatively
lower transaction costs compared with Europe. All of which makes London the
first port-of-call for investment in Europe by almost all overseas investors, DTZ
(2000). For example, over the period 1988-1996, 80 per cent of UK purchase s by
overseas investors were concentrated in London. As a result overseas investors
now hold one-fifth of the total office stock in the city, Lizieri et al. (2000). Overseas
investors have started to diversify out of London (DTZ, 2000), however, 60 per
cent of purchases are still concentrated in London, and the capital still remains the
focus of attention of overseas investment.
This implies that most UK institutional and overseas investor portfolios are
relatively un-diversified. Thus the primary interest of the analyses here is to
investigate the incremental contribution provided by sector and regional
diversification in enhancing the risk/return profile of a real estate portfolio initially
heavily concentrated in London.
However, to take full advantage of such an expansion it may well be that fund
managers will have to design complex weighting schemes. If so, these potential
benefits of sector and regional diversification may be unattainable without perfect
foresight. Alternatively, perhaps the contribution of sector and regional diversification
is attainable with even the most naı
¨ve of investment strategies. Cheng and Liang (2000)
in a comparison of the performance of regional diversification in the US find that
although optimal portfolios do significantly outperform their equal-weighted
alternative on an ex post basis, when the analysis was repeated on an out of sample
basis, there proved to be no statistical difference in performance. Indeed in some cases
Statistical
significance of
sector
395
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