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No clear hierarchy of investment choice.
(ProQuest Information and Learning: ... denotes formula omitted.)
The common belief that asset allocation is the primary investment activity originated with Brinson, Hood, and Beebower (BHB) [1986]. Both BHB and Brinson, Singer, and Beebower (BSB) [1991] conclude that strategic asset allocation accounted for over 90% of the variation in the performance of 91 pension plans over a ten-year period. Ibbotson and Kaplan [2000] have noted it is important to correctly analyze the right question, however; they warn of misinterpretation of the BHB/BSB results.
Kritzman and Page [2003] and Kritzman [2006] note it could be quite hazardous to draw any conclusion on the relative importance of security selection and asset allocation using the methodological approach in BHB/BSB. Kritzman [2006, p. 10] provides a simple numerical example to demonstrate that
most of the variation that they [BHB/BSB] attributed to asset allocation arose not from the choice of the portfolio's asset mix but, instead, from [only] the decision to invest [in anything].1
The debate on the relative importance of asset allocation and security selection took a new turn when Kritzman and Page (KP) adopted a normative approach based on a bootstrap simulation to establish the hierarchy of such investment activities. Their approach is designed to disentangle investor behavior from investment opportunity, as it is based on potential rather than realized portfolio returns. In fact, normative economics-as opposed to positive studies-explores which investment choice has the greatest potential to influence investment results rather than what investors choose to do.
KP [2003, p. 22] essentially find that "asset allocation is the least important investment activity . . . and security selection is the most important investment choice."2 This is an important result that challenges conventional wisdom. KP argue that investors, for a variety of reasons, tend to hug certain benchmarks and avoid engaging meaningfully in security selection.
Some critics, notably Staub [2004], claim that KP implicitly hamstring asset allocation. Staub also questions the normative status of KP's work in arbitrarily establishing the asset mix benchmark at 60% stocks, 30% bonds, and 10% cash. KP [2004] provide a response to each of Staub s criticisms, showing that allowing for greater asset allocation bets in their framework does not invalidate the decision hierarchy.
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