FINM 3008/6016, Applied Portfolio Construction Tutorial #8

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FINM 3008/6016, Applied Portfolio Construction

Tutorial #8 – Outline

This tutorial examines the nature of direct (i.e. unlisted) property as an asset class. The aim is to perform analysis on how direct property relates to listed property, equities, bond yields, inflation and economic growth, i.e. tease out fundamental relationships and determinants. While some basic guidance and hints will be provided, you are encouraged to perform any analysis on the data that you deem appropriate given your skill set.

On the course Wattle site can be found the file “Tutorial #8 - Analysis File.xlsx”. In contains the Australian series listed below, including quarterly observations as well as continuously compounded growth rates over holding periods of 1-quarter, 1-year, 3-years and 5-years.

- Return indices for direct property (DP), listed property (LP) and equities (AE)

- 10-year government bond yields, and their change over the period (ΔBY)

- Consumer price index (CPI) - a measure of realized inflation

- ‘Inflation surprise” (Inf Surp), formed from changes in the break-even inflation series. The latter is estimated from the difference between conventional 10-year bond and inflation-linked bond yields, which reflects a rough proxy for inflation expectations (as discussed in Tutorial #7). It is assumed that changes in this series largely reflect revisions in the market’s inflation expectations.

- Real GDP growth (GDP) - a measure of economic growth

A number of facilities appear through the spreadsheet to provide some assistance with performing analysis to help address the discussion points. The “Data” worksheet has spaces for standard deviations and correlations to be estimated (shaded cells), which in turn are linked to the “SUMMARY” worksheet. There are two charts comparing DP and LP returns, one based on yearly returns and the other plotting the logged total return indices. Cells can be found on the far right of the “Data” worksheet that contain lagged values of the LP series, in case you want to do any regressions to gauge the lag structure between DP and LP.

Discussion points:

(Hint: the use of regressions may provide further insights in addition to what can be gauged in the SUMMARY worksheet)

(a) What is the nature of the economic exposures that arise from Australian DP? (That is, to what extent does DP contain exposure to interest rates, inflation and economic growth?)

(b) What are the key similarities and differences in the economic exposures as compared to LP and AE? (That is, to what extent might DP offer genuine diversification benefits as a ‘growth’ asset, due to differing exposures to fundamental economic factors?)

(c) Does either Australian DP or LP provide a reliable hedge against Australian inflation? (Note: Hedging unexpected inflation might be considered more important, to the extent that expected inflation should already be discounted in asset prices.)

(d) What is the relation between DP and LP returns? In particular, examine whether DP returns are linked to LP returns at any particular lag(s).

(e) To what extent can DP and LP be viewed as substitute assets?