Assessing the consistency of valuation-smoothing and the impact on property in Australian mixed-asset portfolios

The use of valuations in the major property indices has seen valuation-smoothing, leading to under-stated levels of property risk. De-smoothing the property returns has become the standard procedure to obtain more appropriate property risk estimates. The impact of valuation-smoothing on property risk and correlations are assessed for Australian commercial property over 1995-2009. The resulting de-smoothed property risk estimates are shown to need to be increased significantly to account for this impact of valuation-smoothing. The impact of valuation-smoothing on property risk is also shown to vary considerably over time and is influenced by the level of property valuation information available. The resulting impact of valuation-smoothing and more appropriate property risk estimates on the level of property in the mixed-asset portfolio is also assessed. Importantly, even after adjusting for valuation-smoothing, Australian commercial property is still seen to play a significant and important role in the mixed-asset portfolio; further validating the contribution of commercial property as an important asset class in an Australian portfolio.