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Week 4: Modern Portfolio Theory and constructing a property portfolio

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Title: Week 4: Modern Portfolio Theory and constructing a property portfolio


1
Week 4Modern Portfolio Theory and constructing
a property portfolio
2
1. Introduction
  • Modern Portfolio Theory (MPT)
  • Optimum portfolio structure
  • Benchmarking and tracking error
  • Practical portfolio strategy

3
2. Combining assets in a portfolio
  • Expected return
  • E(Rp) wiE(Ri)
  • E(Rp) w1E(R1) w2E(R2)
  • Expected risk

4
3. The principles of MPT
  • Individual asset return and risk are only
    important in that they contribute to portfolio
    return and risk
  • Either for a given level of risk, maximise
    return
  • Or for a given level of return, minimise risk
  • Output proportion of the portfolio to be held in
    each asset (wi) and the expected portfolio
    return and risk

5
4. MPT stages
  • Calculate all possible combinations of risk and
    return.
  • Remove inefficient combinations to identify the
    Efficient Frontier
  • Chose one of the efficient points

6
5. MPT possible combinations and the efficient
frontier
The feasible set
5
Expected return
4
The efficient frontier
3
2
1
Risk
7
6. MPT indifference curves
Expected return
return increasing
I4
I3
I2
I1
Risk
8
7. MPT choosing the optimum portfolio
B
Expected return
A
Risk taking investor
Risk averse investor
Risk
9
8. Problems of applying MPT
  • Input data expectations
  • Determining indifferences
  • Other objectives
  • Defining asset classes
  • Specific risk

10
9. Risk and a benchmark
  • In practice, fund objectives are not set in
    isolation
  • But with reference to competitors or to the
    market as a whole
  • Funds which perform worse than average will lose
    business
  • So objectives are set for return and risk
    relative to a benchmark

11
10. Relative risk and return
  • Expected relative return (structure)
  • Expected risk (tracking error)

12
11. Adding value
  • Value (extra return) can be added in three ways
  • the structure relative to the benchmark take
    positive/negative bets in markets expected to do
    well/badly
  • stock selection mispricing
  • active management of the properties rent
    reviews, lease renewals refurbishment
    development

13
12. Strategy
  • Portfolio strategy is like a business plan
  • statement of objectives
  • portfolio analysis
  • forecasts of return and risk structure and stock
  • comparison with objectives
  • stock issues
  • other practicalities
  • final strategy

14
13. Objectives
  • Benchmark
  • appropriate for business area large lot size
    markets asset management developments specific
    risk speed of portfolio change
  • Return relative to benchmark
  • Risk tolerance tracking error probability of
    underperforming
  • Timescale rolling 3 to 5 years

15
14. Portfolio analysis
  • Current structure relative to benchmark bets
  • What were the managers good at?
  • Attribute recent performance to
  • the market return
  • portfolio return attributable to structure
  • portfolio return attributable to stock
  • RFT RB RFSE RFST

16
15. Expected return and risk
17
16. Achievement of objectives
18
17. Stock factors
  • Number and size distribution of buildings
  • Contrary indications
  • need to complete rent review
  • marriage value
  • refurbishment current or potential
  • development current or potential

19
18. Stock selection
  • Regional forecasts vs town buy/sells
  • Other systematic factors
  • sub-sectors
  • size
  • age
  • lease length
  • Tilted portfolios

20
19. Other practicalities
  • Lot size min/max and average
  • Returns beyond one year
  • Timing
  • New money
  • Market conditions (liquidity) and size
  • Costs
  • Implementation and monitoring

21
20. Final strategy
  • Identify which sector/regions to buy/sell
  • Target stock selection
  • Improve expected return
  • Ensure tracking error is within objective
  • .. but the future is uncertain
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