The Impact of Portfolio Size on the Variability of the Terminal Wealth of Real Estate Funds

Studies have examined the number of properties required reduce the risk in a real estate portfolio. In investigating this issue the research has concentrated on examining the impact of portfolio size on the reduction in the standard deviation of returns from ex post time series data. However, the ex post time series standard deviation is not really relevant to long-term institutional investors, such as insurance companies and pension funds, who are more concerned with the variability of the terminal wealth of their portfolios, from which policy holders and pensioners will derive their benefits. Longterm investors with specific holding period requirements are less concerned with the within period volatility of their portfolios than with the possibility that their portfolio returns will fail to finance their liabilities. The terminal-wealth standard deviation (TWSD) rather than the time-series standard deviation (TSSD) has been proposed as the ‘true’ measure of portfolio variability to such investors. This paper compares the potential benefits and limitations of risk reduction, as measured by TWSD and TSSD, in the UK property market using a large sample of actual property returns over the period 1981 to 1996.