One of the more misunderstood results to come out of the Brinson et al papers is the statement that 90% of a portfolio returns is a result of asset allocation. This paper by Mitch Tuchman gets it wrong. Check the first paragraph under Reducing Risk. 90% of a portfolio return is not tied to asset allocation. What Gary Brinson and his co-authors actually stated in their 1986 paper is found in the following quote.
“Data from 91 large U.S. pension plans over the 1974-1983 period indicate that investment policy dominates investment strategy (market timing and security selection), explaining on average 93.6% per cent of the variation in total plan return.”
Note that critical word, “variation.” Tuchman is not alone in misinterpreting the Brinson research results by leaving out a key word – variation.
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Great post Lowell,
This is indeed critical material!
Hope everybody on your blog read it!
missed a “T”:
“This is indeed critical material!”
Lowell, is there a list of factors that statistically have been shown to explain the variability in portfolio returns. I assume many regression analyses have been done in many different ways, just curious. The quote above that “investment policy” explains 93.6 of the variability or variance in plan returns does not tell me much.
Thanks
John,
In this post I was referring to the Brinson et al. papers (there are two studies) and how they are frequently misrepresented. Part of the problem lies in the title of the article published in 1986 where the title is, “Determinants of Portfolio Performance.” Immediately one is drawn to the article as the implication is – this article will identify what variables (determinants) dictate the returns of a portfolio. The article fails to answer this question, but many authors who site these papers continue to think it is strictly asset allocation that is the end all of portfolio construction. While I still believe asset allocation is extremely important, it is not the whole story.
Brinson examined data from 91 large U.S. pension plans and broke the portfolios into Stocks, Bonds, and Cash. One of my criticisms of the papers is that this is an incomplete breakdown. We know that many of these pensions will hold international equities, real estate, and private equity. In fact, private equity is now a significant percentage in many large endowment funds.
To answer your question, the factors were primarily how the assets were divided between stocks, bonds, and cash. Stock selection and market timing were also considered, but played a smaller role in portfolio variations.
I’m not sure if one can transfer studies from large pension plans over to small investors like those who read this blog.
BTW, Brinson found that active management cost these pension plans 1.2 per cent per year and in some cases added as much as 3.69% to the cost. They would have been better off to invest in large index funds, not a lot different than recommended on this blog. 😉
Lowell
Platinum readers:
I have a file folder on asset allocation that is about 3″ thick. One article by Mike Clowes is titled, “Allocation Confusion.” A review of this article is too long to publish in Comments so I will reserve it for a blog post. There is a lot of interesting conclusions in one page article.
Stapled to the Clowes article is another paper written by Roger Ibbotson and Paul Kaplan. Ibbotson research is highly respected and this article, “Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?” is worth a review. Stay tuned for a blog post on the importance of asset allocation sometime in the next week.
Lowell
Thanks!