To evaluate these issues two approaches are adopted; first, an analysis of the correlations within the sectors and regions and secondly simulations of property portfolios of increasing size constructed both naively and with value-weighting.
Using these methods it is shown that the extent of possible risk reduction is limited because of the high positive correlations between assets in any portfolio, even when naively diversified. It is also shown that portfolios exhibit high levels of variability around the average risk, suggesting that previous work seriously understates the number of properties needed to achieve a satisfactory level of diversification.
The results have implications for the development and maintenance of a property portfolio because they indicate that the achievable level of risk reduction depends upon the availability of assets, the weighting system used and the investor’s risk tolerance.
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