Chaotic financial markets and mounting fears of a global liquidity squeeze have sent a convulsive shudder through property investors around the world.

The uncertainty generated has highlighted some of the glaring weaknesses of property investment; first, it is a "lumpy" asset which cannot be purchased or disposed of quickly. Second, there is no instrument against which investors can hedge their bets, either betting on a free-fall or a sharp rise in values.

Any direct property investor who decided that August was the time to get out of property was too late.

Thus, news last month that the Chicago Mercantile Exchange has applied for regulatory approval for an exchange-traded instrument based on the Standard & Poor's Real Estate Investment Trust (Reit) Index should have been welcome.

This is a capitalisation-weighted index comprising 105 Reits traded on US equity exchanges. Rick Redding, vice-president in charge of index products at the CME, says the intended users are money managers, and managers at institutions and pension funds which invest in property but are unable to increase or reduce their exposure quickly.

The traded Reit sector in the US, Mr Redding notes, has really only been formed within the past five years, from a market capitalisation in 1993 of no more than $10 billion.

"There has to be a broad enough base of companies so that no one company or handful of companies could dominate the index," he says. It is only very recently that the sector has become sufficiently large to have an index of its own.

However, property investors note one big problem. "It will absolutely mimic the performance of Reits," says Iain Reid, chief executive at Barclays Property Investors. "But it won't mimic the performance of real estate."

Property shares are simply not a proxy for the underlying real estate market. This is the case in the US, the UK and most markets where a real estate index of any sort exists.

Data from Property & Portfolio Research, a Boston-based real estate econometrics firm, show just how out of line Reit shares are with the underlying market as measured by the best existing benchmark, the Nacreif direct property index. In the first six months of 1998, the Nacreif offered returns of 8.3 per cent while the Nareit Index shrunk 5.03 per cent in value.

The Nacreif Index between 1978 and 1997 offered average annualised returns of 9.0 per cent while NAREIT offered returns of 16 per cent. Using a narrower measure since 1993, Nacreif returned an average 7.8 per cent each year while Nareit's average annualised returns were 18.3 per cent.

Historically, there was a 0.03 per cent correlation between the two indices although since 1993, that has improved to 0.22 per cent.

Mr Reid says that achieving a liquid, useful property hedge in any market remains an elusive goal, and no market has any hope of developing a hedging instrument without a credible index for benchmarking.

Indeed, he says, the creation of the UK's Investment Property Databank Index has played a crucial role in Barclays' creation of the only hedging instrument for direct property which exists anywhere in the world. Barclays has two products:

PIFs, which are effectively contracts for differences in which one investor agrees to pay another on an agreed future date the difference between the capital value of his property and the capital return of the IPD Index, and

Property Income Certificates (PICs), which are bonds that provide a return equal to the IPD Index as of a certain date.

Barclays is in talks with investors on the type of product most needed in the market, and is investigating the possibility of hedging instruments tailored to specific sectors, such as retail warehouses. Susan Hudson-Wilson, president of Property & Portfolio Research and chairman of the Pension Real Estate Association - a group of pension funds which invest directly in property - says there is growing demand for an effective hedging instrument from occupiers as well as from investors.

In the US, she says, the problem is that neither of the two indices is terribly robust. The UK's IPD Index is far superior to any available in her home market.

But the biggest problem, she says, is that none of the existing indices are transaction-based. Most data are valuers' appraisals, which may or may not reflect true market values.