Practical applications of portfolio optimisation tend to proceed on
a “top down” basis where funds are allocated first at asset class level
(between, say, bonds, cash, equities and real estate) and then, progressively,
at sub-class level (within property to sectors, office, retail, industrial
for example). While there are organisational benefits from such an approach,
it can potentially lead to sub-optimal allocations when compared to a “global”
or “side-by-side” optimisation. This will occur where there are correlations
between sub-classes across the asset divide that are masked in aggregation
– between, for instance, City offices and the performance of financial
services stocks. This paper explores such sub-class linkages using UK monthly
stock and property data. Exploratory analysis using clustering procedures
and factor analysis suggests that property performance and equity performance
are distinctive: there is little persuasive evidence of contemporaneous
or lagged sub-class linkages. Formal tests of the equivalence of optimised
portfolios using top-down and global approaches failed to demonstrate significant
differences, whether or not allocations were constrained. While the results
may be a function of measurement of market returns, it is those returns
that are used to assess fund performance. Accordingly, the treatment of
real estate as a distinct asset class with diversification potential seems
justified.
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