Do real estate mutual funds enhance portfolio returns and reduce portfolio risk?

This study examines both the determinants of risk-adjusted returns of real estate mutual funds relative to that of five categories of equity mutual funds and the systematic risk/return impacts on mutual fund portfolios when combined with real estate mutual funds. We find that there are three variables that are significant in affecting risk-adjusted returns of real estate mutual funds: correlation with stock market returns, expense ratio and tax efficiency. Real estate funds with returns that have a greater association with stock market returns would have larger risk-adjusted returns. Low tax efficiency and larger expense ratios would lead to reduced risk-adjusted returns. This study provides evidence of the positive risk/return impacts of including real estate mutual funds in a portfolio of equity mutual funds. Combining real estate mutual funds into equally weighted portfolios with non-real estate mutual funds would have increased portfolio returns while decreasing portfolio beta. Copyright © 2005 John Wiley & Sons, Ltd.