The Equal Importance of Asset Allocation and Active Management

Posted: 16 Apr 2010

See all articles by James X. Xiong

James X. Xiong

Morningstar Investment Management

Roger G. Ibbotson

Yale School of Management; Zebra Capital Management, LLC

Thomas M. Idzorek

Morningstar Investment Management

Peng Chen

Ibbotson Associates

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Date Written: April 16, 2010

Abstract

What is the relative importance of asset allocation policy versus active portfolio management in explaining variability in performance? Considerable confusion surrounds both time-series and cross-sectional regressions and the importance of asset allocation. Cross-sectional regressions naturally remove market movements; therefore, the cross-sectional results in the literature are equivalent to analyses of excess market returns even though the regressions were performed on total returns. In contrast, time-series analyses of total returns do not naturally remove market movements. Time-series analyses of excess market returns and cross-sectional analyses of either total or excess market returns, however, are consistent with each other. With market movements removed, asset allocation and active management are equally important in determining portfolio return differences within a peer group. Finally, an examination of period-by-period cross-sectional results reveals why researchers using the same regression technique can get widely different results.

Keywords: Performance Measurement and Evaluation, Performance Attribution, Portfolio Management, Asset Allocation

Suggested Citation

Xiong, James X. and Ibbotson, Roger G. and Idzorek, Thomas and Chen, Peng, The Equal Importance of Asset Allocation and Active Management (April 16, 2010). Financial Analysts Journal, Vol. 66, No. 2, 2010, Available at SSRN: https://ssrn.com/abstract=1591156

James X. Xiong (Contact Author)

Morningstar Investment Management ( email )

22 W Washington
Chicago, IL 60602
United States

Roger G. Ibbotson

Yale School of Management ( email )

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6021 (Phone)
203-432-6970 (Fax)

Zebra Capital Management, LLC ( email )

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Stamford, CT 06902
United States
203 701 5900 (Phone)

Thomas Idzorek

Morningstar Investment Management ( email )

22 W Washington Street
Chicago, IL 60602
United States

Peng Chen

Ibbotson Associates ( email )

225 North Michigan Avenue
Suite 700
Chicago, IL 60601
United States
(312) 616-1620 (Phone)
(312) 616-0404 (Fax)

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