German open ended funds: was there a valuation problem?

In late 2005, a number of German open ended funds suffered significant withdrawals by unit holders. The crisis was precipitated by a long term bear market in German property investment and the fact that these funds offered short term liquidity to unit holders but had low levels of liquidity in the fund. A more controversial suggestion was that the crisis was exacerbated by a perception that the valuations of the fund were too infrequent and inaccurate. As units are priced by reference to these valuations with no secondary market, the valuation process is central to the process. There is no direct evidence that these funds were over-valued but there is circumstantial evidence and this paper examines the indirect evidence of the process to see whether the hypothesis that valuation is an issue for the German funds holds any credibility. It also discusses whether there is a wider issue for other funds of this nature or whether it is a parochial problem confined to Germany. The conclusions are that there is reason to believe that German valuation processes make over-valuation in a recession more likely than in other countries and that more direct research into the German valuation system is required to identify the issues which need to be addressed to make the valuation system more trusted.

Property funds: how much diversification is enough?

t is well known that when assets are randomly-selected and combined in equal proportions in a portfolio, the risk of the portfolio declines as the number of different assets increases without affecting returns. In other words, increasing portfolio size should improve the risk/return trade-off compared with a portfolio of asset size one. Therefore, diversifying among several property funds may be a better alternative for investors compared to holding only one property fund. Nonetheless, it also well known that with naïve diversification although risk always decreases with portfolio size, it does so at a decreasing rate so that at some point the reduction in portfolio risk, from adding another fund, becomes negligible. Based on this fact, a reasonable question to ask is how much diversification is enough, or in other words, how many property funds should be included in a portfolio to minimise return volatility.