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A Practitioner's Guide to Asset Allocation by Harry M. Markowitz, David Turkington, Mark P. Kritzman, William Kinlaw

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CHAPTER 3The Importance of Asset Allocation

FALLACY: ASSET ALLOCATION DETERMINES MORE THAN 90 PERCENT OF PERFORMANCE

No doubt, asset allocation is important, even critical, to investment success. Otherwise, why would we bother to write this book? Nonetheless, most investors, as well as academics, have a much inflated perception of the value of asset allocation compared to security selection.

THE DETERMINANTS OF PORTFOLIO PERFORMANCE

This misperception can be traced to an influential article published in the Financial Analysts Journal in 1986 called “The Determinants of Portfolio Performance.”1 The authors, Gary Brinson, Randolph Hood, and Gilbert Beebower, analyzed the performance of 91 large corporate pension plans during the 10‐year period from 1974 to 1983 in an effort to attribute their performance to three investment choices: asset allocation policy, timing, and security selection.

They defined the asset allocation policy return as the return of the long‐term asset mix invested in passive asset class benchmarks. They then measured the return associated with deviations from the policy mix assuming investment in passive benchmarks, and they attributed this component of return to timing. Finally, they measured the return associated with deviations from the passive benchmarks within each asset class and attributed this component of return to security selection. For each of the 91 funds, they regressed total return through time on these respective components of return. These ...

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