Portfolio structure, real estate investment and the performance of defined contribution pension funds

With the growing importance of defined contribution (DC) pension funds around the world, concerns have arisen over their ability to provide adequate income replacement for members and the liquidity of their invesments. The first part of this thesis focuses on the illiquidity associated with real estate investments. The first chapter provides a discussion of liquidity within the context of DC pension funds. The second empirical chapter employs the tracking error optimisation procedure in the construction of portfolios that include direct real estate and selected liquid, publicly traded assets. We find that this helps to improve the performance of these blended portfolios. In the second part of this thesis, we look at various ways in which the real value of DC pension contributions can be preserved. The third empirical uses contemporary econometric approaches in the analysis of the dynamic relationship between asset returns and inflation/interest rate changes. Real estate and bonds were found to be a hedge against all the inflation/interest rates measures analysed. Some non-UK assets were also found to be a good hedge against selected benchmarks. The fourth empirical chapter of this PhD thesis examines the optimal allocation within portfolios designed to hedge against the various inflation and interest rate benchmarks. When the investment objective is to strictly track these benchmarks, bonds and real estate dominate the portfolios. Real estate, stocks and alternative assets receive significant allocations within the portfolios constructed to provide maximum risk adjusted returns relative to the minimum return benchmarks. We observe that the allocation to real estate reduced significantly following the global financial crisis period with bonds appearing to take its place. On the whole, this thesis contributes to the discussion on how best DC pension portfolios could be designed to comply with current investment regulations regarding liquidity and minimum returns requirements

Optimal composition of hybrid/blended real estate portfolios

Purpose: The purpose of this paper is to establish an optimum mix of liquid, publicly traded assets that may be added to a real estate portfolio, such as those held by open-ended funds, to provide the liquidity required by institutional investors such as UK defined contribution pension funds. This is with the objective of securing liquidity while not unduly compromising the risk-return characteristics of the underlying asset class. This paper considers the best mix of liquid assets at different thresholds for a liquid asset allocation, with the performance then evaluated against that of a direct real estate benchmark index. Design/Methodology/Approach: The authors employ a mean-tracking error optimisation approach in determining the optimal combination of liquid assets that can be added to a real estate fund portfolio. The returns of the optimised portfolios are compared to the returns for portfolios that employ the use of either cash or listed real estate alone as a liquidity buffer. Multivariate Generalised Autoregressive models are used along with rolling correlations and tracking errors to gauge the effectiveness of the various portfolios in tracking the performance of the benchmark index. Findings: The results indicate that applying formal optimisation techniques leads to a considerable improvement in the ability of the returns from blended real estate portfolios to track the underlying real estate market. This is the case at a number of different thresholds for the liquid asset allocation and in cases where a minimum return requirement is imposed. Practical Implications: The results suggest that real estate fund managers can realise the liquidity benefits of incorporating publicly traded assets into their portfolios without sacrificing the ability to deliver real estate-like returns. However, in order to do so, a wider range of liquid assets must be considered, not just cash. Originality/value: Despite their importance in the real estate investment industry, comparatively few studies have examined the structure and operation of open-ended real estate funds. To the authors’ knowledge, this is the first study to analyse the optimal composition of liquid assets within blended or hybrid real estate portfolios