Abstract

http://ssrn.com/abstract=279096
 
 

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Does Asset Allocation Policy Explain 40, 90, 100 Percent of
Performance?


Roger G. Ibbotson


Yale School of Management; Zebra Capital Management, LLC

Paul D. Kaplan


Morningstar, Inc.


Financial Analysts Journal, Jan/Feb 2000, Vol. 56, No. 1

Abstract:     
Does asset allocation policy explain 40 percent, 90 percent, or 100 percent of performance? According to some well-known studies, more than 90 percent of the variability of a typical plan sponsor's performance over time is attributable to asset allocation. However, few people want to explain variability over time. Instead, an analyst might want to know how important it is in explaining the differences in return from one fund to another, or what percentage of the level of a typical fund's return is the result of asset allocation. To address these aspects of the role of asset allocation policy, we investigated these three questions.

1. How much of the variability of returns across time is explained by asset allocation policy?

2. How much of the variation of returns among funds is explained by differences in asset allocation policy?

3. What portion of the return level is explained by returns to asset allocation policy?

We examined 10 years of monthly returns to 94 balanced mutual funds and 5 years of quarterly returns to 58 pension funds. For the mutual funds, we used return-based style analysis for the entire 120-month period to estimate policy weights for each fund. We carried out the same type of analysis on quarterly returns of 58 pension funds for the five-year 1993-97 period. For the pension funds, rather than estimated policy weights, we used the actual policy weights and asset-class benchmarks of the pension funds.

We answered the three questions as follows:

#1: We regressed each fund's total returns against its policy return and recorded the RSQ value for each fund in the study. We found that, on average, about 90 percent of the variability of returns of a typical fund across time is explained by asset allocation policy. Most of a fund's ups and downs are explained by the ups and downs of the overall market.

#2: We ran a cross-sectional regression of compound annual fund returns for the entire period on compound annual policy returns. We found that about 40 percent of the variation of returns from one fund to another is explained by policy return differences. For example, among mutual funds, if one fund's return is 13 percent and another fund's return is 8 percent, then on average, about 2 percent of the difference is explained by the difference in asset mix policy; the remaining 3 percent difference is explained by other factors, such as timing, security selection, and fee differences between the funds.

#3: For each fund, we divided the compound annual policy return for the entire period by the compound annual fund return. We found that, on average, about 100 percent of the return level is explained by the return to asset allocation policy. Thus, the average fund's return to asset-mix policy is about the same as the return to the benchmarks for the asset classes.

In summary, our analysis shows that asset allocation explains about 90 percent of the variability of a fund's returns over time but explains only about 40 percent of the variation of returns among funds. Furthermore, on average across funds, asset allocation policy explains slightly more than 100 percent of the levels of returns. Thus, the answer to the question of whether asset allocation policy explains 40 percent, 90 percent, 100 percent of performance, depends on how the question is interpreted.

JEL Classification: G11

Accepted Paper Series


Not Available For Download

Date posted: October 5, 2001  

Suggested Citation

Ibbotson, Roger G. and Kaplan, Paul D., Does Asset Allocation Policy Explain 40, 90, 100 Percent of Performance?. Financial Analysts Journal, Jan/Feb 2000, Vol. 56, No. 1. Available at SSRN: http://ssrn.com/abstract=279096

Contact Information

Roger G. Ibbotson (Contact Author)
Yale School of Management ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6021 (Phone)
203-432-6970 (Fax)
Zebra Capital Management, LLC ( email )
612 Wheelers Farms Road
Milford, CT 06461
United States
Paul D. Kaplan
Morningstar, Inc. ( email )
225 W. Wacker Drive
Chicago, IL 60606-1229
United States
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