In research sponsored by the National Association of Real Estate Investment Trusts (NAREIT), investment advisory firm Wilshire Associates came out in favor of the role of REITs and listed real estate equities in target-date fund asset allocations.
In its report titled "The Role of REITs and Listed Real Estate Equities in Target Date Fund Asset Allocations," Wiltshire advocated for greater inclusion of REITs in TDFs.
According to the research report, an updated version of a 2012 study—also NAREIT-sponsored—REITs offer several benefits when incorporated into investment portfolios.
Among them are better performance and lower risk than other asset classes, it said, pointing to the 40-year period between 1986 and 2015 during which "listed equity REITs had low correlations with other major asset classes, as well as providing a high annualized return."
The report pointed out that long-term correlations of equity REITs with other major asset classes can provide some protection from portfolio volatility, thus offering some diversification benefits. They also offer "inflation protection comparable to that of fixed income assets and superior to that of equities and commodities."
In determining that REITs should have a greater role to play, Wilshire looked at portfolios through the lenses of both mean variance optimization (MVO), which allocates assets to maximize portfolio returns while controlling for the variance of those returns, and surplus optimization (SO), a variant of MVO that takes the target liability (retirement income) into account.
It said that SO allocates assets to maximize the expected surplus return above the growth of the liability while controlling for expected surplus risk.
In designing the glide path of TDFs, Wilshire said that elements of both MVO and SO should be considered. "For portfolios with medium- to long-term investment horizons," the study said, "asset growth typically is most important, leading to a primary role for asset allocations using MVO.
However, for portfolios with short- to medium-term investment horizons as well as portfolios for those in retirement, hedging retirement liabilities is most important, leading to a primary role for asset allocations using SO."
Reviewing the historical performance of portfolios constructed with SO and REITs, it said, yielded the highest historical return and lowest level of risk.
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