While subsequent research challenged this notion, most of this research evaluated liquid assets, such as stocks and bonds, and did not consider the impact of private strategies. Here we will create a simple framework to evaluate the impact from asset allocation versus manager selection using different portfolio implementations.
For definitional purposes:
Asset Allocation is defined as the return associated with the market return for public asset classes and the median return for private strategies.
Manager Selection is defined as the return associated with all investment decisions other than asset allocation including portfolio construction, manager selection, tactical allocation or thematic investing and security selection.
An indexed portfolio of 70% equities and 30% bonds utilizing a passive approach derives all its return from asset allocation. This makes sense since there are no active manager selection decisions.
If active managers (i.e., active risk) are added to a traditional portfolio, almost 90% of the returns come from asset allocation consistent with the basic conclusion of the Brinson, Hood, Beebower study in 1986.
| Traditional Portfolio | Portfolio Asset Allocation | Underperforming Active Return | Passive Return |
Outperforming Active Return |
| Equity | 70% | 7.0% | 8.0% | 9.0% |
| Fixed | 30% | 3.5% | 4.0% | 4.5% |
| Portfolio Return | 6.0% | 6.8% | 7.7% | |
| Percent Return from Asset Allocation | 88% | 100% | 89% | |
| Percent Return from Manager Selection | 13% | 0% | 11% |
If illiquid private investment strategies are included, as is often this case for an endowment style investing framework, the investor experiences a greater degree of dispersion in portfolio outcomes. This is driven by the much wider manager dispersion historically experienced in private strategies as seen below.
| Global Public Equity Managers | All Privates Funds | |
| Top Quartile | 10.4% | 16.4% |
| Median | 9.4% | 8.6% |
| Bottom Quartile | 7.7% | 1.0% |
Source: 10 Year returns ending 9/30/24 Global Equity Managers Evestment. All private funds ending 9/30/24 Burgiss Database.
| Endowment Portfolio | Portfolio Asset Allocation | Underperforming Active Return | Passive Return |
Outperforming Active Return |
| Equity | 35% | 6.0% | 8.0% | 10.0% |
| Fixed | 15% | 3.5% | 4.0% | 4.5% |
| Alternatives | 50% | 1.0% | 8.0% | 15.0% |
| Portfolio Return | 3.1% | 7.4% | 11.7% | |
| Percent Return from Asset Allocation | 42% | 100% | 63% | |
| Percent Return from Manager Selection | 58% | 0% | 37% |
Note: A higher level of active risk is assumed relative to equities of 2 percent. Alternatives return assumption is 8 percent which approximates the median return for all private investments in Burgiss Database. Further, the 7 percent return spread around the median approximates the historical return spread in the Burgiss Database.
Asset allocation is still a major driver of total returns, but as active risk and illiquidity increases, manager selection becomes a larger driver of portfolio performance. Most institutional portfolios sit somewhere along the spectrum of the portfolios presented above. The below chart highlights a simple framework when thinking about what determines portfolio returns.