The landmark study in … by Brinson, Beebower, and Hood concluded that 95% of the variability of pension fund returns can be explained by asset allocation. Subsequent studies have corroborated that the mix of asset classes determines over 90% of a portfolio’s performance. Security selection and timing are found to be only marginal factors.
Investment advisors quickly latched on to the study and proclaimed asset allocation as essentially the sole determinant of portfolio returns. Industry practitioners began to invest passively, utilizing broad index funds in place of active managers. There is only one problem. The study proclaims that asset allocation explains 95% of the variability of returns. It makes no conclusions on the actual level of returns, or much less, the actual realized returns. This subtle difference has been largely ignored.
While short-term investors no doubt pay much heed to the volatility of returns, long-term investors should care much less. Instead, long-term investors care much more with with the end-point amount of their capital rather than the inter-temporal fluctuations of their capital. Newer studies explain that the impact of asset allocation is a more modest 40%; other investment decisions including manager selection, market timing, sector rotation, do matter. Nevertheless, asset allocation does indeed play a large part in the level of returns.
We start with understanding the allocation strategies of the top university endowments. They represent the best-in-class allocations of the institutional investment world, and importantly, publicly disclose their strategies annually. We also reference the allocation strategies of the best (U.S.-based) asset allocation fund managers. This allows us to get insight into the thinking of some of the world’s best asset allocation and portfolio construction practitioners.
- Top university endowments: Harvard, Yale, Stanford, et al.
- Target-date fund managers: JP Morgan, BlackRock, Vanguard, T. Rowe Price, Fidelity
- Top institutional asset allocation investment research managers:
- Research Affiliates: 10-year expected returns for a comprehensive selection of asset classes
- AQR: various research including asset allocation
- GMO: 7-year return forecasts for a collection of asset classes
- Bridgewater: the risk parity concept and the “All Weather” strategy
- Top investment writers: William Bernstein, Roger Gibson, Richard Ferri