The True Impact of Asset Allocation on Returns

by Roger G. Ibbotson

"From the marketing materials of mutual fund companies and financial planning firms to the mouths of academics and financial representatives, there is a universal misunderstanding of the relationship between asset allocation and performance.  The specific claims vary, but financial professionals generally assert that asset allocation is the most important determinant of returns, accounting for more than 90 percent of performance."

"This assertion stems from studies by Brinson et. al. (1986, 1991), that state, "...investment policy dominates investment strategy (market timing and security selection), explaining on average 93.6 percent of the variation in total plan return."  This conclusion has caused a great deal of confusion in both the academic and financial communities.  In fact, a survey by Nuttall & Nuttall (1998) demonstrates that out of 50 writers who quoted Brinson, only one quoted him correctly.  Approximately 37 writers misinterpreted Brinson's work as an answer to the question, "What percent of total return is explained by asset allocation policy?" and five writers misconstrued the Brinson conclusion as an answer to the question, "What is the impact of choosing one asset allocation over another?"

What the Brinson Studies Explain

"According to the well-known studies by Brinson et al., more than 90 percent of the variability of a portfolio's performance over time is due to asset allocation.  Brinson is measuring the relationship between the movement of a portfolio and the movement of the overall market.   He finds that more than 90 percent of the movement of one's portfolio from quarter to quarter is due to market movement of the asset classes in which the portfolio is invested."

Here is the conclusion from the Ibbotson study.

"In summary, the impact of asset allocation on returns depends on an individual's investing style. For the long-term, passive investor, the asset allocation decision is by far the most important.  For the short-term investor who trades more frequently, invests in individual securities, and practices market timing, asset allocation has less of an impact on returns.  The impact of asset allocation on performance is directly correlated with investment style."

The above quotes come directly from the Ibbotson paper.