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Ever since 1986, when "Determinants of Fund Performance" by Gary Brinson, Randolph Hood and Gil Beebower1 (BHB) called attention to the subject, the money-management industry has been preoccupied with the role played by asset allocation. Is asset allocation the key issue in investment planning? Or is it just one item of many? Finally, I'm happy to report, the discussion may be considered closed.
This winter and spring, Financial Analysts Journal and Journal of Investing published four new articles on the subject.2 With convergence! All papers agreed on two critical issues: (1) Asset allocation cannot be said to be 93.6 percent of the investment story and (2) any attempt to attach a precise figure to its importance is futile.3 Certainly asset allocation matters, but-to quote Harold Evensky-attempting to quantify its importance leads to statistical arguments "akin to resolving how many angels can fit on the head of a pin."4
Okay, you're thinking, if four articles were just released on BHB, why does the world need a fifth version? Because mine is the shortest! Also, unlike the other articles, I'll pass along the lessons that we can actually gain from BHB. They're usefulalthough quite different than those drawn by even the authors themselves.
What BHB Isn't About
"Over 90 percent of portfolio performance is determined by asset allocation."
"80-90 percent of investment returns are decided by the strategic asset allocation."
"A 1986 study by Brinson Hood & Beebower indicates that...the asset allocation decisions that investors make are by far the single greatest determinant for future investment success."5
You know the story: The ending wealth of a portfolio depends almost exclusively on its asset allocation. It's an attractive notion. Were this to be true, the investment problem would then simplify getting the asset allocation correct. After all, if asset allocation is 90 percent of the story, how much trouble can that final 10 percent really create?
Unfortunately, the common interpretation of BHB is dead wrong. As this spring's authors all acknowledge, once you examine the problem closely, you'll realize that there are, in fact,...