Diversification by sector, region or function? A mean absolute deviation optimisation

Abstract

This study utilises a large sector‐regional real estate data set, based on actual properties in more than 187 locations in the UK over the period 1981‐1995. This is subjected to a portfolio analysis using an algorithm based on mean absolute deviation as the measure of risk. The algorithm is especially effective when the number of assets is greater than the number of time periods, as is typically the case within a real estate portfolio analysis. In addition, such a large data set enables a comparison of the performance of several “conventional” regional classifications with one based on economic (Functional) criteria. The general conclusion to be drawn from this is that diversification by sectors across a Super Region would have outperformed almost all other diversification strategies. However, in comparing Functional grouping with this Super Regional approach, this economically based classification produced results that were equally good.

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