Strategic Asset Allocation and Other Determinants of Portfolio Returns

This article challenges the prevalent notion that more than 90% of the variability of returns is determined by strategic asset allocation. The authors critically review five methodological issues surrounding studies by Brinson and colleagues in 1986 and 1991 that concluded strategic asset allocation determines more than 90% of the variability of returns. They then present an alternative study, which uses a slightly different framework and covers a longer time horizon than the earlier work, includes alternative assets, and utilizes synthetic portfolios. Using identical calculations, they find that on average strategic asset allocation explained 77.5% of the variability of portfolio returns, while security selection accounted for 10.3%, and tactical asset allocation explained 5.6%. Though the authors thus agree that strategic asset allocation is a major determinant of investment performance, they argue that the investment process should not be limited to strategic asset allocation, as managers can potentially add value through tactical asset allocation and security selection. Although the contributions of security selection and tactical asset allocation may seem small, the power of compounding returns makes them significant to individual investors.