Introducing REITs (Real Estate Investment Trusts) to Enhance the Risk Adjusted Returns of the Risky Direct Real Estate Portfolio

Purpose :The paper has several objectives in mind: to examine whether or not a dynamic, ex ante AHP-SAA model and a dynamic Markowitz QP TAA model that utilizes de-smoothed data, produces an investment strategy, which further optimizes the risk-adjusted return of the pan-Asian real estate portfolio. It examines the required de-smoothing and Modern Portfolio Theory (MPT) for the TAA.Design/Methodology/Approach :This paper reveals that the efficient frontier of risk-adjusted returns for direct real estate portfolio is enhanced by introducing REITS. The portfolio comprises the Pan-Asian office and industrial real estate markets for 13 major Asian cities, to which Asian REITS are added. Direct real estate total return data is in its “ smooth ” form while the REIT data is “ de-smoothed ” under the 1 st and 4 th order autoregressive model. The efficient frontier is constructed under a dynamic Strategic Asset Allocation (SAA) model, incorporating the Analytic Hierarchy Process (AHP) approach. Secondly, the dynamic Markowitz quadratic-programming Tactical Asset Allocation (TAA) model is adopted to obtain a geographically and real estate sector diversified portfolio.Findings :The resulting efficient frontier with the de-smoothed data reveals a higher overall TR for every corresponding standard deviation as compared to the smoothed data. TAA for the de-smoothed returns would lie on the efficient frontier at the maximum Sharpe ratio of 1.44 with a TR on 15.30% and a standard deviation of 7.31%. Conversely, TAA for the smoothed returns would lie on the efficient frontier at the maximum Sharpe ratio of 1.31 with a lower TR of 14.2% and a standard deviation of 7.18%.Practical implications : This paper should serve as a meaningful guide to look at an alternative asset allocation process that can be effectively adopted and refined by practitioners and researchers. It enables asset managers/or investors to deploy expert opinions on an ex ante basis for a longer term dynamic SAA model and a short term dynamic Markowitz QP TAA model.Originality/Value : The paper offers insightful information for in adopting the AHP to develop a dynamic SAA and the dynamic Markowitz QP TAA model in utilizing de-smoothed direct real estate TR data. This paper is specific to a Pan Asian direct real estate portfolio of 13 Asian cities together with the introduction of Asian REITS, to provide greater diversification and risk-return benefits.