A quantitative study about the effectiveness of using real estate investment trusts to diversify a portfolio

Abstract

This study examines the performance of Real Estate Investment Trusts (REITs) to determine how REITs can be integrated efficiently into a portfolio in order to maximise risk-adjusted returns. This was done by extracting the returns of a REIT index over a 15 year period between 2005 and 2019, and comparing those returns to three other asset classes, namely equity stocks, corporate bonds and government bonds. All four asset classes were represented by two securities each, one from the US economy and one from the European economy. The findings suggest that in general, REITs have higher returns and higher volatility when compared to corporate bonds and government bonds and perform most similar to equity stocks with regards to returns and volatility. More specifically, when analysing the data, it was found that over the relevant 15 year period, REITs were heavily affected by market volatility and economic fluctuations, like during the financial crisis of 2007-2008, and it was determined that although REITs have a high correlation with equity stocks, they actually have slightly lower returns and increased volatility when calculating the average returns and volatility between 2005 and 2019 for those two asset classes. After analysing all of the returns, volatility, Sharpe ratios and correlation coefficients of the four asset classes, it was concluded that Real Estate Investment Trusts are best used when implanted into a portfolio with corporate bonds and treasury bonds, in order to maximise risk-adjusted returns.