Question

26) Recent articles have cited the movement of U.S. investor wealth into Emerging Market stocks and into real estate investment trusts (REIT’s) here in the U.S. Analysts claim that both investment vehicles “offer a significant source of portfolio diversification”. Why might this be?

(a) for each investment, the stand-alone volatility is now clearly lower than U.S. stocks

(b) these investments now offer higher long-term rates of return

(c) with low correlations with U.S. stock returns, these asset classes reduce portfolio risk

(d) risk-free rates of return are lower in emerging markets

Answer 1

From portfolio diversification point of view (C) is the best suited answer. As the co-relation of US stocks (large cap, mid cap, small cap) is differently correlated. As the investor wealth has drifted a portion to REIT's and emerging market stocks it can reduce the overall portfolio risk as the portfolio will be further diversified.

It is to be noted that all the other 3 points can also be right.

Now coming to (A) Volatility may be lower or may not be, depending upon the market situation.

(B) Rate of return again is dependent on the market, at times large cap funds give more return than mid cap and small cap, vice-versa.

(C) When markets give negative returns, at that point risk-free rates do give more return than emerging market.