Publicly traded property stocks allow investors to gain exposure to real estate, an illiquid asset class, without sacrificing the liquidity benefits of listed equities. Property stocks also typically offer higher yields than the broad equity market, may serve as an effective inflation hedge and may help diversify a portfolio due to their generally low correlations to stocks and bonds.
S&P Dow Jones Indices and NZX Limited jointly launched the S&P/NZX Real Estate Select in November 2015 to serve as an investable benchmark for real estate companies listed on the NZX. The index includes the largest, most liquid property companies included in the S&P/NZX All Index. To reduce single stock concentration, the index employs a stock cap of 17.5%, applied semiannually.
Total returns and volatility of New Zealand equities, as measured by the S&P/NZX 50 Index, and property stocks, as measured by the S&P/NZX Real Estate Select, were relatively similar over the longer term (see Exhibit 1). This is somewhat surprising, given that global property stocks have historically had higher volatility than the broader global equity market. As expected, investment grade bond returns were more modest, but much less volatile than equities and property stocks.
As shown in Exhibit 2, the S&P/NZX Real Estate Select historically had relatively low correlations to both the S&P/NZX 50 Index and the S&P/NZX Composite Investment Grade Bond Index.
Exhibits 3 and 4 illustrate the potential diversification benefits of adding a listed property allocation to a stylized equity or equity/bond portfolio. For example, a hypothetical 80%/20% combination of the S&P/NZX 50 Index and S&P/NZX Real Estate Select resulted in a reduction in volatility of over 70 bps compared with a 100% position in the S&P/NZX 50 Index. This reduction was driven by the relatively low correlation between the indices.