Asset Allocation and the Performance of Real Estate Mutual Funds

Abstract

We examine the performance of real estate mutual funds during January 1991–December 1997. As a group, the sampled funds outperformed the Wilshire Real Estate Securities Index on a risk‐adjusted basis by more than 5 percentage points annually. We attempt to explain these surprising findings by examining the fund's asset allocations across stocks, bonds and real estate property types using Sharpe's (1992) effective‐mix test. We find that all of the superior performance is attributable to fund managers' decisions to overweight outperforming property types (apartments and health care) relative to the Wilshire Real Estate Securities Index weights. Performance of the funds matches a multiple‐property‐type benchmark that takes account of the fund's exposure to each property type. Therefore, real estate funds demonstrated superior allocation across property types, but neither superior nor inferior selection within property type, during 1991–1997. Our findings emphasize the importance of asset allocation for real estate mutual‐fund performance.

Can US Real Estate Mutual Funds Beat the Market? New Evidence

“…Kallberg et al (2000) find strong and robust evidence for outperformance on 44 REMFs from 1986 to 1998, irrespective of various benchmark applications -CAPM, Fama-French three factor models, or passive real estate market index proxied by Wilshire Real Estate Index and NAREIT Index. Gallo et al (2000) find outperformance among 24 REMFs for the period of 1991 to 1997 when the Wilshire Real Estate Index is employed.…”

“…In contrast to the findings of outperformance by Kallberg et al (2000) and Gallo et al (2000), more recent studies (such as O'Neal and Page, 2000; Lin and Yung, 2004;Rodriguez, 2007;Chiang et al, 2008) Most of the earlier studies examine performance using only the net returns of funds (Kallberg et al, 2000;Gallo et al, 2000;O'Neal and Page, 2000;Lin and Yung, 2004;Rodriguez, 2007;Chiang et al, 2008), and overlook the interaction between fund's expense costs and performance. Unlike the other REMF studies, Hartzell et al (2010) examine funds' returns before and net of costs and find evidence of outperformance with respect to an index benchmarks derived from NAREIT and Wilshire.…”

“…Such specialized sector equity funds are exposed to real estate sector risk. Many studies employ the US passive stock index or real estate sector index as the benchmark for fund's returns, net of operating expenses, to measure REMF performance (Kallberg et al, 2000;Gallo et al, 2000;O'Neal and Page, 2000;Lin and Yung, 2004;Rodriguez, 2007;Chiang et al, 2008). The use of a real estate market index as the benchmark is justified by the excess sector risk exposure of REMF portfolios holdings towards the real estate industry, compared with other well diversified funds.…”

“…Specifically, by applying simple passive index benchmarks, earlier researchers tend to find evidence for outperformance (Kallberg et al, 2000;Gallo et al, 2000), although later studies show no sign of significant outperformance when both a passive market index benchmark and passive portfolio benchmark from a risk factor model are used (Lin and Yung, 2004;Chiang et al, 2008). Kallberg et al (2000) find strong and robust evidence for outperformance on 44 REMFs from 1986 to 1998, irrespective of various benchmark applications -CAPM, Fama-French three factor models, or passive real estate market index proxied by Wilshire Real Estate Index and NAREIT Index.…”

“…One final issue is survivor bias. The findings on outperformance in the literature are subject to the in-built survivor bias of the data sources, such as Morningstar (Kallberg et al, 2000;Gallo et al, 2000;O'Neal and Page, 2000;Rodriguez, 2007;Chiang et al, 2008) and Yahoo Finance Lin and Yung (2004), which causes overestimation of outperformance.…”