Key Investment Principle #4… Portfolio Structure Explains Performance
One of the questions that the academic community spent a great deal of time researching over the years was this: Of all the decisions that are made regarding the way we manage an investment portfolio, what is it in the decision-making process that can most enhance the performance of a portfolio?
The answer was found in a 1986 ground-breaking research study by Gary Brinson of Brinson, Hood and Beebower titled "Determination of Portfolio Performance".
His study analyzed the reasons for performance variations between securities portfolios...with the goal of trying to understand what it was that added the most value to a portfolio over time. The issues involved were: Asset Class Selection (how assets are allocated in a portfolio...i.e. how much in stocks, how much in bonds and how much in cash), Market Timing (shifting portfolio assets in and out of the market or between asset classes), and Stock Selection (finding the "best" stocks, bonds or mutual funds to own).
The study's somewhat surprising conclusion was that the asset allocation decision was by far the most significant determinant of portfolio performance...accounting for over 90% of the variation of portfolio returns, with market timing and stock selection accounting for the remainder of the variation. More recent studies have come up with different variations of the original study, but all agree that asset allocation plays a dominant role in determining the variability of performance.
These findings were quite extraordinary, and they served to reinforce the notion that an academic-based investment approach that focuses on asset allocation is truly the antithesis of the more traditional "star" system employed by most institutional portfolios.