A Framework for Examining Asset Allocation Alpha

Abstract

Despite the large body of literature on the importance of asset allocation as a primary determinant of portfolio performance, the definition of asset allocation “alpha” remains a poorly defined concept. In this article, we show that a portfolio’s total alpha can be decomposed into alpha from asset allocation and manager selection. The asset allocation alpha can then be further attributed to value-add from:

1) taking additional risk exposure relative to the policy portfolio,

2) exploiting the relative value differential between assets with similar risk exposures, and

3) timing the cyclicality in risk premia.

Keywords: asset allocation, alpha, portfolio performance

JEL Classification: G10, G11