102 INSTITUTIONAL FUNDS are not representative of individual markets.
For example, EPRA Germany contains only eight stocks. Second, publicly traded commercial real estate is only a small portion of total real estate in any economy, especially in the United States. In fact, owner-occupied housing is often one of the largest investments that an average investor holds during his or her lifetime. It is thus natural that one would suggest including it in the market portfolio. Unfortunately, most housing is owner occupied, and as such is not a readily tradable asset. Due to high transaction costs and imperfect information, consumers are unlikely to trade their primary residence frequently. In his 1977 paper, Roll had suggested that the true market portfolio was not observable mainly because human capital, which is often considered the most important part of aggregate assets, cannot be measured or observed. In fact, Jorgen-son and Fraumeni6 suggest that nearly 93 percent of all wealth and resources of the United States are in the form of human capital. Gary Becker (1997) asserts that human capital is the most important type of wealth in the United States and other modern nations. Since human capital occupies such a dominant position in average investors' portfolios, it is impossible to ignore it when discussing the market portfolio. However, it is important to note that the market portfolio consists of assets that are divisible and can be freely sold in the marketplace. Human capital possesses neither of these characteristics. In addition, modeling human capital for inclusion in the model portfolio is impeded by the lack of a generalized measure. Although a number of measures (such as growth rate in labor income along with a term that depends on future expected returns) have been proposed, they are hard to implement. While it is clearly very difficult to measure the value of human capital, most economists would agree that the fluctuations in its aggregate value must correlate highly with the aggregate returns on the public equity markets. Thus, although we know that human capital is important and difficult to measure, one might hope that its absence from a market portfolio does not significantly alter the risk characteristics of that portfolio. Private equity, discussed in detail in Chapter 28, usually refers to investments in companies that are not quoted on a public exchange. In spite of its many complexities (illiquidity, unpredictability, and increased liability), the demand for institutional investments in private equity has been rising. In fact, in 2001 the top 1,000 defined benefit plans held 3.8 percent in private equity (up from 3.4 percent in 2000).7 According to Venture Economics/Thomson Financial's 2001 Investment Benchmarks Reports, $170 billion was committed to private equity that year. Given that private equity represents securities or agreements that are claims on real assets, one may suggest that it should be included in the market portfolio. Its illiquid nature, though, would lead one to think that private equity is not readily tradable. In addition, due to the limited partnership nature of private equity investments, there are no indexes that document their historical performance or total sSee Jorgenson, D. W., and B. Fraumeni, 1989, "The Accumulation of Human and Non-Human Capital, 1948-84," in The Measurement of Saving, Investment, and Wealth, edited by R. E. Lipsey and H. S. Tice, NBER Studies in Income and Wealth, 52, 227-282. 7Source: Pensions & Investments, "The P&I 1000: Our Annual Look at the Largest Pension Funds," January 21, 2002.
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