Academic journal article IBAR

Irish Property Funds: Empirical Evidence on Market Timing & Selectivity

Academic journal article IBAR

Irish Property Funds: Empirical Evidence on Market Timing & Selectivity

Article excerpt

Simon A.W. Stevenson, Raymond P. Kinsella, Ruairi S. O'Healai*

Introduction

The evaluation of fund performance has received a large amount of attention in finance literature over the last thirty years, however very little work has expanded this analysis to the property sector. This paper aims to redress some of this imbalance by examining the performance of Irish based property funds, concentrating specifically on the timing and selection ability of the funds. In the context of this analysis timing ability (or macroforecasting) refers to the ability of portfolio managers to correctly assess market movements and to respond accordingly in terms of the assets held. Selectivity (or microforecasting) refers to the ability of fund managers to choose individual assets. This paper will examine eleven Irish property funds over the period 1985 to 1996 using the parametric models developed by Henriksson and Merton (1981) and Chen & Stockum (1986). In addition, the non-parametric model proposed by Henriksson & Merton (1981) will also be analysed. Due to the requirement for this latter analysis of fund allocation details, these tests can only take place over the period 1992 to 1996. In the context of this analysis Twenty Six funds will be examined.

In addition to the problems concerned with the selection of funds used, there are also a number of issues that are specifically related to the property market. The general characteristics of the property market can lead to a number of problems in the application of financial theory. Some of these issues bear directly on the tests carried out in this paper. Due to the inherent illiquidity, indivisibility and lack of marketability in the property sector, it can perhaps be expected that the results achieved will be technically less efficient compared with those which, in principle, could be generated by managers of fixed income and equity funds. Fund managers will not be as able to deploy assets as effectively as in the capital markets, due to the nature of the asset. This is particularly so in the case of a property market within a small and open economy, such as Ireland.

The proxy used to measure the performance of the market as a whole is an additional issue which needs to be addressed. Lee (1993) notes that problems concerning the proxy are particularly important when the asset under examination is property due to the lack of an index that reflects the true nature of the market. Morrell ( 1993), states that property's heterogeneous nature leads to difficulties, as individual property returns will be diverse. Whilst this is also true for equities the important difference is that property investors cannot `hold the index' as equity investors can. Morrell argues that not only is each property unique, but, equally, so too is each portfolio or index: Therefore he argues, "property portfolio selection can be seen as sampling from the total population without replacement".

Indivisibility, when combined with heterogeneity, causes a number of problems, in particular, specific risk is far more important in property portfolios. Brown ( 1988) examined the reduction of risk in property portfolios, and found that in order to explain in excess of 95%le of the variation, a sample of two hundred properties was required. The corresponding figure in the case of equities is forty five stocks. This means that very few investors can construct a highly diversified property component that does not, at the same time, result in too high an allocation of property in the overall portfolio. The consequences of these factors are quite severe. The common assumptions in relation to risk - reduction which are taken for granted in the financial markets, do not apply in equal measure in property. The importance of specific risk attributable to particular properties means that few investors will be able to hold fully diversified property portfolios. This brings into focus the extent to which market wide indices are robust benchmarks. …

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