More than three decades ago, The Financial Analysts Journal in the US published a seminal research paper – Determinants of portfolio performance by Brinson, Hood and Beebower – concluding that a broadly diversified portfolio’s strategic asset allocation is the primary driver of its return variability over time.
This research is just as critical and pertinent for today’s investors.
In the many years since the first publication of Determinants of portfolio performance, a series of research projects, some of which Vanguard has produced, have strongly confirmed that getting the strategic or target asset allocation right really matters. The importance of an appropriate asset allocation would be difficult to understate.
Brinson, Hood and Beebower examined the returns from 1974 to 1983 of 91 US retirement funds with diversified portfolios against the index returns for identically-diversified portfolios. They found that 93.6 per cent of variations in the retirement funds’ returns were attributable to the underlying strategic asset allocation.
Fast forward to today. Recently-published Vanguard research measured the influence of asset allocations on the returns from January 1990 to June 2016 of more than 3400 diversified funds in Australia, US, UK, Canada, Japan, and Hong Kong:
- 600 Australian diversified funds: 89.3 per cent of their return variations were attributable to asset allocation.
- 770 US diversified funds: 91.5 per cent of their return variations were attributable to asset allocation.
- 739 Canadian diversified funds: 89.6 per cent of their return variations were attributable to asset allocation.
- 792 UK diversified funds: 77 per cent of their return variations were attributable to asset allocation.
- 467 Japanese diversified funds: 87.8 per cent of their return variations were attributable to asset allocation.
- 74 Hong Kong diversified funds: 84.8 per cent of their return variations were attributable to asset allocation.
In order to measure the contribution of asset allocation, Vanguard analysts needed to distinguish between what the portfolios in the study would have earned if recreated with passively managed index funds and the actual return earned by the actively-managed funds.
A message highlighted by this latest research is that setting an appropriate strategic asset allocation for an investor’s circumstances is a starting point for all investors before considering investment selection.
Broadly diversified portfolios with limited market-timing tend to move over time in tandem with overall financial markets. Market-timing and actual security selection had a relatively small impact on return variability over the long term.
