Q 4:
Determine the most appropriate index to represent the expected chracteristics of direct investment in real estate. Justify your response with 2 reasons: (betwewen smoothed and unsmooted)
Answer: The unsmoothed NCREIF Index is the most appropriate index to represent the expected characteristics of Vizyon’s proposed investment in real estate. The unsmoothing corrects for biases in the NCREIF index such as infrequent appraisal-based valuations, making the NCREIF (unsmoothed) reflect the true underlying characteristics (and higher) volatility and correlations with other assets in the portfolio.
The other indices are not the most appropriate to use for the following reasons:
- Using the NCREIF Index (unadjusted) overstates the benefits of allocating assets to direct real estate. The NCREIF Index is based on infrequent appraisal-based property values and therefore tends to underestimate both the volatility in market value and the correlation with other asset classes (thus showing an inflated Sharpe ratio).
Is it justification or not?