The allocation to property in the multi‐asset portfolio: The evidence and theory reconsidered

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Abstract
Studies which use modern portfolio theory (MPT) to calculate the optimal allocation to property in a multi‐asset portfolio are fundamentally flawed. These suggest optimal theoretical allocations for property which are much higher than actual allocations to property. Criticism can be made of: the exclusion of other eligible assets from the analysis; the use of a mean‐variance optimization technique on estimated data; the inadequacies of the historical data which understates risk and correlation and may overstate return; the changing characteristics of property as an investment; the indivisibility of property and the consequent difficulties in achieving a diversified property portfolio; the complexity of risk as a concept compared to the simple and simplistic definition used in MPT; and the omission of explicit consideration of differential liquidity. An alternative which offers a more practicable framework for decision‐making is a combination of econometric techniques to forecast income under differing economic scenarios and a discounted cash flow valuation model. This would produce a proper expectations‐based analysis of return and risk. However, it will always be important to understand the complexity of investors objectives as these extend far beyond the simple return‐risk trade‐off used in MPT.

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