Market segmentation and portfolio management An analysis of

Market segmentation and portfolio management An analysis of the Italian property market Luigi Pischedda Davide Manstretta Roberto Martinez Diaz On the pulse of the property world

Aim of the study On the pulse of the property world l Real estate investors use diversification as a risk-reducing factor when deciding their portfolios’ asset allocation. l Market segmentation is a way of determining the asset allocation which will diversify the portfolio, that is, minimise the overall risk of the portfolio at the expenses of the smallest possible reduction in returns. l The way in which market segmentation achieves this result is by grouping together assets with similar return profiles. The assets thus clustered together will show a small variance in returns within each of the segments, which will in turn differ greatly from one another, as far as performance is concerned. l IPD provides the market with a standard segmentation from which institutional investors who own one or more balanced portfolios can draw inspiration for their investment strategies. l The present study shows the explanatory power of the IPD standard segmentation with respect to the variability of returns for the Italian market, and explores a few alternative segmentations. Sources: IPD www. ipd. com

The IPD Italian universe On the pulse of the property world Main sector weights as a %age of market value l As at the end of 2009, the databank included circa 1, 600 properties, for a total market value of over Euro 19 bn. l Traditionally, the office sector has been the main focus of institutional investors’ asset allocation. 2009 year end Sources: IPD Since index inception www. ipd. com

The IPD standard segmentation for the Italian property market Once again, a focus on the office sector Sources: IPD www. ipd. com On the pulse of the property world

The IPD standard segmentation for the Italian property market On the pulse of the property world Once again, a focus on the office sector l The amount of office data collected led the IPD standard segmentation to a greater breakdown for offices: Sources: IPD www. ipd. com

The IPD standard segmentation for the Italian property market On the pulse of the property world Explanatory power (R 2, 1 yr total return) l R 2 indicates the proportion of variability in returns explained by the chosen segmentation. The average R 2 for the 13 segments of the standard segmentation over the 6 years considered is 9. 7%. Sources: IPD www. ipd. com

The trade-off: explanatory power vs. complexity On the pulse of the property world Standard segmentation, minimum and maximum breakdown l We expect that increasing the number of segments the explanatory power of the segmentation increases too, and vice versa: l But are investors ready to deal with the amount of complexity caused by an extremely detailed segmentation? Sources: IPD www. ipd. com

The trade-off: explanatory power vs. complexity Standard segmentation, minimum and maximum breakdown l The three segmentations behave as expected: ØMin breakdown: average R 2 = 6. 3% ØStandard: average R 2 = 9. 7% ØMax breakdown: R 2 = 18. 6% Sources: IPD www. ipd. com On the pulse of the property world

The trade-off: explanatory power vs. complexity Standard segmentation, minimum and maximum breakdown l The results are confirmed using 3 yrs rolling average ØMin breakdown: average R 2 = 10. 8% ØStandard: average R 2 = 16. 5% ØMax breakdown: R 2 = 26. 9% Sources: IPD www. ipd. com On the pulse of the property world

Introducing alternative segmentations On the pulse of the property world Detailed breakdown for offices & retail and offices & industrial l What happens to the explanatory power of the segmentation if we slightly increase the number of segments? Sources: IPD www. ipd. com

Introducing alternative segmentations Detailed breakdown for offices & retail and offices & industrial l Offices & retail vs. Offices & industrial: ØStandard: average R 2 = 9. 7% ØOffices & retail: R 2 = 15. 3% ØOffices & industrial: R 2 = 10. 3% Sources: IPD www. ipd. com On the pulse of the property world

Introducing alternative segmentations Detailed breakdown for offices & retail and offices & industrial l Offices & retail vs. Offices & industrial: ØStandard: average R 2 = 16. 5% ØOffices & retail: R 2 = 23. 8% ØOffices & industrial: R 2 = 18. 7% Sources: IPD www. ipd. com On the pulse of the property world

Conclusions On the pulse of the property world l IPD provides the market with a standard segmentation from which institutional investors who own one or more balanced portfolios can draw inspiration for their investment strategies. l The explanatory power of the IPD standard segmentation can be improved by adding as many as 9 segments (given the current size of the databank), but the price of explaining up to 27% of the variability in returns (R 2 3 yrs rolling average) is an increased complexity. l An R 2 of nearly 24% (3 yrs rolling average) can be achieved by a small increment in the number of segments if we consider a relatively detailed breakdown for offices and retail. l Future improvements to the study might include the geographic segmentation for the retail sector and the calculation of the probability of outperformance when stockpicking within the segments. Sources: IPD www. ipd. com

Thank you for your time On the pulse of the property world Luigi Pischedda IPD 1 St John’s Lane London EC 1 M 4 BL United Kingdom Direct: +44 (0)20 7336 9303 Mobile: +44 (0)20 75080 10900 Fax: +44 (0)20 7336 9399 Email: luigi. pischedda@ipd. com www. ipd. com Intellectual Property Rights and use of IPD statistics as benchmarks Whether in the public domain or otherwise, IPD's statistics are the intellectual property of Investment Property Databank Limited. It is not permissible to use data drawn from this presentation as benchmarks. © Investment Property Databank Limited (IPD) 2008. Database Right, Investment Property Databank Limited (IPD) 2008. All rights conferred by law of copyright and by virtue of international conventions are reserved by IPD www. ipd. com