Diversification benefits of SA REITs in a mixed asset portfolio: one decade and a pandemic later

Abstract

Volatility spillover between financial markets causes inefficiency of diversification. Therefore, other investment alternatives are required to build an optimal portfolio, one of them being Real Estate Investment Trusts (REITs). The low correlation between REITs and stocks implies an advantage of diversification in an investment portfolio containing both assets. An important implication of this finding is that if stocks and REITs are incorporated into an investment portfolio, the investor will have better diversification benefits. This paper looks at the diversification benefits of having REITs in a mixed asset portfolio by conducting an empirical study from when the REIT regime came into effect in South Africa 10 years ago, particularly focusing on the period between 2013 and 2023. The econometric tools used in this regard include cointegration and, time series models (VAR and VECM) for forecasting. The paper also considers how the COVID-19 pandemic has affected this relationship by conducting a mean-variance spanning test to see if the inclusion of REITs in an existing portfolio dominates it. Other measures such as Sharpe ratios and Efficient Frontiers are included for analysing portfolio performance. Therefore, providing a mature analysis of REITs continuing from current literature and assisting Fund Managers in understanding the impact of including the asset class in a portfolio with a long-term investment horizon. This study affirms the low correlation between REITs and other stocks and further shows that they are not affected by shocks in the bond and stock markets respectively while also having the potential to improve the risk-adjusted returns of a Portfolio. Therefore, Fund Managers can consider REITs for their portfolio diversification strategies.