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8/3/2019 BHB1986_determinants of Portfolio Performance
http://slidepdf.com/reader/full/bhb1986determinants-of-portfolio-performance 1/6
1985-1994
Determinants of Portfolio Performance
Gary P: Brinson, L. Randolph Hood, and Gilbert L. Beebower
A r e c e n t s t udy i nd ic a t es t ha t mor e tha n 80 pe r,cent of all corpor ate p ens ion plan s w ith as.sets
grea te r than $2 bi l l ion have more than 10 manag-
er s , and of a l l p lans wi th asse ts grea te r than $50mil l ion, less than one- thi rd have only one inves t -
me n t ma n a ge r . ~ M a n y f und s t ha t e m ploy mul t i p l e
managers focus the i r a t tent ion sole ly on the prob-
l e m of ma na ge r s e l e c t i on . O nly now a r e somef unds be g inn ing t o r e a li z e t ha t t he y m us t de ve lop
a me thod f o r de l i ne a t i ng r e spons ib i l i t y a nd me a -su r ing t he pe r f o r ma nc e c on t r i bu t i on o f t hose a c -t i v i t i e s t ha t c ompose t he i nve s tme n t ma na ge me nt
p r oc e s s - - - inve s tme n t po l ic y , m a r ke t t iming a ndsecuri ty selection. 2
The re la t ive impor tance of pol icy, t iming andse lec t ion can be de te rm ine d only i f we have a c lear
a nd r e l e va n t me tho d o f a t t ri bu t ing r e tu r ns t o t he se
factors. This ar t icle examines empir ically the ef-
f e c t s o f i nve s tme n t po l i c y , ma r ke t t iming a nd
secur i ty (or manager ) se lec t ion on tota l por t fol io
re turn. Our goa l i s to de te rmine , f rom his tor ica li nve s tm e n t da t a on U .S . c o r por a t e pe ns ion p l a ns ,
w hic h i nve s tme n t de c i s i ons ha d t he g r e a t e s t im-pa c t s on t he ma g n i tude o f t o ta l r e tu r n a nd on t he
var iabil i ty of tha t r e turn .
A FRAMEWORK FOR ANALYSISWe de ve lop be low a f r a me w or k t ha t ca n be use d t odecompose tota l por t fol io re turns . Conceptua l ly
va l id , ye t computa t iona l ly s imple , th is f ramework
has b een u sed successful ly by a var ie ty of ins t i tu-t i ona l pe ns ion sponsor s , c onsu l t a n t s a nd i nve s t -
me n t m a na ge r s ; i t is c u r r e n t l y be ing use d t o a t-
t r ibute per formance cont r ibut ions in ac tua lportfolios.
Per form ance a t t r ibut ion, whi le no t new , i s s ti llan evo lving disc ipl ine . Ear ly papers on th e subjec t,
f oc us ing on r i sk - a d jus t e d r e tu r ns , sugge s t e d t heini t ia l f r amework, but pa id l i t t le a t tent ion to mul-
t ip l e a s se t pe r f o r ma n c e m e a sur e m e nt . 3 O ur t a sk i s
t o r a nk i n o r de r o f impor t a nc e t he de c i s i ons ma deby i nve s tme n t c l i e n t s a nd ma na ge r s , a nd t he n t o
me a s ur e t he ove r al l impor t a nc e o f t he se de c i si ons
to ac tua l plan per formance .
Reprinted rom Financial AnalystsJournal(July~August 1986):39-44.
Table I i l lus t ra tes the f ram ewo rk for ana lyz in gpor t fol io re turns . Quadrant I r epresents pol icy.
Here w e w o u l d p l ac e t h e f u n d ' s b e n c h m a r k r e t u rn
f o r t he pe r iod , a s de t e r mine d by i t s l ong- t e r m
inve s tme n t po l i c y.
A p l a n ' s be nc hma r k r e tu r n i s a c onse que nc e
of the investment policy a d o p t e d b y t h e p l a n s p o n -
sor . Inves tment pol icy ident i f ies the long- te rm
asse t a l loca t ion plan ( inc luded asse t c lasses and
norm al weights) se lec ted to cont rol the overa l l r i sk
and me et fund objec tives . In shor t , pol icy ident i -
f ies the ent i re plan ' s norm al por t folio . 4 To ca lcula te
the po l i cy be nc hm a r k r e tu r n , w e ne e d (1 ) t heweights of a l l asse t c lasses , spec i f ied in advance ,
and (2) the pass ive (or benc hm ark) re turn ass igned
to each asset class. 5
Q ua dr a n t I I r e p r e se n t s t he r e tu r n e f f e c t s o f
pol icy and t iming. T iming i s the s t ra tegic un de r or
overw eight in g of an asse t c lass re la t ive to i t s nor -
ma l w e igh t , f o r pur pose s o f r e tu r n e nha nc e me nt
a nd /o r r i sk r e duc t i on . T iming i s unde r t a ke n t o
achieve incrementa l r e turns re la t ive to the pol icyr e tu r n .
Q ua d r a n t I II r e p r e se n t s r e tu r ns due t o po l ic y
and secur i ty se lec t ion. Secur i ty se lec t ion i s the
ac t ive se lec t ion of inves tments within an asse tc lass . We def ine i t as the por t fol io ' s ac tua l asse t
c lass re turns (e .g . , ac tua l r e turns to the segments
o f c ommon s toc ks a nd bonds ) i n e xc e s s o f t hose
c l a s se s ' pa s s ive be nc hma r k r e tu r ns a nd w e igh t e d
by the normal to ta l fund asse t a l loca t ions .
Q ua dr a n t I V r e pr e se n t s t he a c tua l r e tu r n t o
the tota l fund for the per iod. This i s the resul t of
t he a c tua l por t f o l i o s e gme nt w e igh t s a nd a c tua l
se gme nt r e tu r ns .
Table 2 presents the methods for ca lcula t ing
the va lues for these quadrants . Table 3 gives thec omputa t i ona l me thod f o r de t e r min ing t he active
r e tu r ns ( t hose r e tu r ns due t o i nve s tme n t strategy).
O ur f r a me w o r k c l e a rly d i f fe r e n ti a t es be tw e e n
the e f f e c t s o f i nve s tme n t po l i c y a nd i nve s tme n t
s t ra t e gy . I nve s tme n t s t r at e gy is show n to be c om-
posed of t iming, secur i ty (or manager ) se lec t ion,and the e f fec ts of a c ross-prod uc t te rm. W e canca lcula te the exac t e f fec ts of pol icy and s t ra tegy
us ing t h e a lge bra i c me a sur e s g ive n .
Financial Analysts Journal/January-February 1995 133
© 1995, AIMR ®
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1985-1994
Table 1. A Simplified Framework for Retu mAccoumaUHty
bt)
SelectionActual Passive
<
(IV)
ActualPortfolioReturn
(III)Policy and
SecuritySelectionReturn
(II)Policy and
TimingReturn
(i )Policy Return
(PassivePortfolio
Benchmark)
Active Returns Due to:Timing II - ISelection I I I- IOther IV - I I I - I I + ITotal IV - I
Table 2. Cornputalional Requirem ents for RetumAccoumU,ty
00 3
0~
SelectionActual Passive
(IV)
~i(Wai • Rai)
(III)Ei(Wpi • Rai)
(ii)
Ei(Wai • Rpi)
(I)Ei(Wpi • Rpi)
Wpi = policy (passive) weight for asset class iWai = actual weight for asset class iRpi = passive return for asset class iRai = active return for asset class i
T o t es t t h e f r a m e w o r k , w e u s e d d a t a f r o m 91
p e n s i o n p l a n s i n th e S E I L a r g e P l a n U n i v e r s e . S E I
h a s d e v e l o p e d q u a r t e r l y d a t a f o r a c o m p l e t e 1 0-
y e a r ( 4 0 - q u a r t e r ) p e r i o d b e g i n n i n g i n 1 9 7 4 ; t h i s
w a s c h o s e n a s th e b e g i n n i n g o f t h e p e r i o d f o r
s t u d y .
I n o r d e r t o b e s e l e c t e d , a p l a n h a d t o s a t i s f y
s e v e r a l c r it e ri a . E a c h p l a n h a d t o h a v e b e e n a
c o r p o r a t e p e n s i o n t r u s t w i t h i n v e s t m e n t d i s c r e t i o n
s o l e l y i n t h e h a n d s o f t h e c o r p o r a t i o n i t s e l f ( i . e ., n o
e m p l o y e e - d e s i g n a t e d f u n d s ) . L a r g e p la n s w e r e
u s e d b e c a u s e o n l y t h o s e p l a n s h a d s u f f i c i e n t r e -
t u r n a n d i n v e s t m e n t w e i g h t i n f o r m a t i o n t o s a t i s f y
o u r c o m p u t a t i o n a l n e e d s . P u b l i c a n d m u l t i - e m -
p l o y e r p l a n s w e r e e x c l u d e d , b e c a u s e l e g i s l a ti v e ,
l e g a l o r o t h e r c o n s t r a i n t s c o u l d h a v e d r a m a t i c a l l y
a l t e r e d t h e i r a s s e t m i x e s f r o m w h a t m i g h t h a v e
o b t a i n e d .
T h e s a m p l e r e p r e s e n t s a m a j o r p o r t i o n o f t h e
l a r g e c o r p o r a t e p e n s i o n p l a n s o f S E I ' s c l i en t s o v e r
t h e 1 0 - y e a r p e r i o d . T h e m a r k e t c a p i t a l i z a ti o n o f
i n d i v i d u a l p l a n s i n t h e u n i v e r s e r a n g e s f r o m a p -
p r o x i m a t e l y $ 1 0 0 m i l l i o n a t t h e b e g i n n i n g o f t h e
s t u d y p e r i o d t o w e l l o v e r $ 3 b i l li o n b y i t s e n d .
T a b l e 4 s u m m a r i z e s t h e d a t a c o l l e c t e d f r o m
e a c h p l a n . N o r m a l w e i g h t s f o r e a c h a s s e t c l a s s f o r
e a c h p l a n w e r e n o t a v a i l a b l e . W e t h u s a s s u m e dt h a t t h e 1 0 - y e a r m e a n a v e r a g e h o l d i n g o f e a c h
a s s e t c l a ss w a s s u ff i c ie n t to a p p r o x i m a t e t h e a p p r o -
p r i a t e n o r m a l h o l d i n g . 6 P o r t fo l i o s e g m e n t s c o n -
s i s t e d o f c o m m o n s t o c k s , m a r k e t a b l e b o n d s ( fi x ed
i n c o m e d e b t w i t h a m a t u r i t y o f a t l e a s t o n e y e a r ,
a n d e x c l u d i n g p r i v a t e p l a c e m e n t s a n d m o r t g a g e -
b a c k e d s e c u r i t i es ) , c a s h e q u i v a l e n t s ( fi x ed i n c o m e
o b l i g a t io n s w i t h m a t u r i t i e s l e s s t h a n o n e y e a r ) a n d
a m i s c e l l a n e o u s c a t e g o r y , " o t h e r , " i n c l u d i n g c o n -
v e r t i b l e s e c u r i t i e s , i n t e r n a t i o n a l h o l d i n g s , r e a l e s -
t a t e , v e n t u r e c a p i t a l , i n s u r a n c e c o n t r a c t s , m o r t -
g a g e - b a c k e d b o n d s a n d p r i v a te p l a c e m e n t s .
B e c a u s e a c o m p l e t e h i s t o r y o f t h e c o n t e n t s o f
t h e " o t h e r " c o m p o n e n t i s n o t a v a i la b l e f o r m a n y
p l a n s , w e e l e c t e d t o e x c l u d e t h i s s e g m e n t f r o m
m o s t o f t h e a n a l y s i s . W e i n s t e a d c a l c u l a t ed a
c o m m o n s t o c k / b o n d s / c a s h e q u i v a l e n t s u b p o r f f o l i o
f o r u s e i n a l l q u a d r a n t s except t h e t o t a l f u n d a c t u a l
r e t u r n ; h e r e w e u s e d t h e a c t u a l r e t u r n a s r e p o r t e d
( i n c l ud i n g " o t h e r " ) . W e c o n s t r u c t e d t h e s u b p o r t -
Table 3. CalculaUon of Active Contributions to Total P~fomnance
Return Due to: Calculated by: Expected Value
Timing
Security selection
Other
Total
Z[(Wai • Rpi) - (Wp i. Rpi)] >0(Quadrant II - Quad rant I)E[(Wpi • Rai) - (Wp i. Rpi)] >0(Quadrant I II - Quadrant I)E[(Wai - Wpi ) (Rai. Rpi)] N/A
[Quadrant IV - (Quadrant II + Quadrant II I+ Quadrant I)]E[(Wai • Rai) - (W pi. Rpi)] >0(Quadrant IV - Quadrant I)
134 Financial Analysts Joum al/ January-February 1995
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1985-1994
Table 4. Summary f Holdings of 91 Large Pension Plans, 1974-1983
StandardHoldings Average M i n i m u m M a x i m u m Deviation Policy Benchmark
All holdings
Common stock
Bonds
57.5%
21.4
Cash equivalents 12.4Other 8.6
Total 100~0%
32.3% 86.5% 10.9% S&P 500 Total ReturnIndex (S&P 500)
0.0 43.0 9.0 Shearson Lehman
Government/CorporateBond Index (SLGC)
1.8 33.1 5.0 30-Day Treasury Bills0.0 53.5 8.3 None
Stocks, b onds and cash only
Common stock 62.9% 37.9%Bonds 23.4 0.0Cash equivalents 13.6 2.0
Total !00.0%
89.3% 10.6%51.3 9.435.0 5.2
folio by eliminating the "othe r" in vestment weightfrom each plan in each quarter an d calculating new
weights and portfolio returns for the components
that remained; this had the effect of spreading the
"other" weight proportionally across the remain-
ing asse t classes. The bot tom panel of Table 4 give s
the weighting information.
Table 4 also gives the market indexes used aspassive bench mark returns. 7 For comm on stocks,
we u sed the S&P 500 composite index total retu rn.
The S&P comes unde r freq uent attack for not being
representative of the U.S. equity market; we nev-
ertheless selected it, for several reasons. First, the
S&P is still quoted and used as a benchmark bymany plan sponsors; this indicates its continued
acceptance. Second, it is one of the few indexes
known over the entire study period, and actually
available for investment by plan sponsors via, for
example, index fun ds. Third, the S&P 500 does not
suffer from the lack of liquidity that affects some
segments of the broader market indexes. For com-
pleteness, howev er, we recomput ed all the calcu-
lations performed below using the Wilshire 5000
Capitalization Weighted Total Return Index in
place of the S&P; the results wer e v irtually identi-
cal.
We chose the Shearson Lehman Government /
Corporate Bond Index (SLGC) for the bond com-
ponent passive index; this is representative of all
publicly traded, investment-grade bonds (exclud-
ing mortgage-backed securities) with a maturity of
at least one year and a minimum par amount
outsta nding of $1 million. We used the total return
on a 30-day Treasury bill for cash equivalents.
RESULTSTo analyze the relative importance of investment
policy versus investment strategy, we began bycalculating the total returns for each of our 91
portfolios. Table 5 repeats the framework outlined
in Table 1 and provides a mean of 91 annualized
compound total lO-year rates of return for each
quadrant.
Table 5. Mean Annualized Returns by AcUvity, 91Large Plans, 1974-19 83
i
Selection
Actual Passive
<
O9
0~
(IV)9.01%
(III)9.75%
(II)9.44%
(i)lO.11%
Active Retums Due to:Timing -0.66%Security Selection -0.36Other -0.07
Total active return -1.10%
The mean average annualized total returnover the 10-year period (Quad rant IV) was 9.01 per
cent. This is the return to the entire plan portfolio,not just the common stock/bonds/cash equivalents
portio n of the plan. 8 The averag e pl an lost 66 basis
points per year in market timing and lost another
Financial Analysts Journal/January-February 1995 135
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1985-1994
36 bas i s po in t s per year f rom secur i ty se lect ion .
The mea n averag e annual ize d to ta l re turn for the
normal p lan pol icy (pass ive index re turns and
average weight ing) for the sample was 10 .11 percent (Quadrant I ) .
Table 6 provides more deta i l on the var ious
e f fec ts of ac t iv e m an ag e m en t an d i n v es t m en t p o l -
i cy a t work . The ef fect o f marke t t iming on theco m p o u n d an n u a l r e t u rn o f i n d iv i d u a l p lan s
ranged f rom +0.25 to - -2 .68 per cen t per year over
the per iod . The ef fect o f secur i ty se lect ion ranged
f ro m +3 . 6 0 t o -2 . 9 0 p e r cen t p e r y ea r . On av e r -
age, to ta l ac t ive mana gem ent cos t the average p lan
1 .10 per cen t per year . I t s ef fect s on ind iv idualp lans var ied , how eve r , f rom a lo w of - -24 .17 per
cent per year to a h igh of +3 .69 per cen t peryear- -a range of 7 .86 per cen t .
deci s ion , we w oul d see l ess of a t ende ncy to
clus ter asse t mix pol icy accord ing to "peer imi ta-t i o n " o r " co n v en t i o n a l " i n v es t m en t p o s t u res .
Retum VadalJon
The ab i l i ty of inves tment po l icy to d ic ta te
actual p lan re turn requi res fur ther analys i s. Table 7
examines the re la tive amo unt of var iance cont r ib-u t ed b y each q u ad ran t t o t h e r e t u rn t o t h e t o t a l
por t fo l io . I t thus addresses d i rect ly the re la t ive
impor tance of the deci s ions af fect ing to ta l re turn .
T h e f i g u res h e re r ep res en t t h e av e rag eamounts of var iance of to ta l por t fo l io re turn ex-
p l a i n ed b y each o f t h e q u ad ran t s . T h ey were
calcu la ted by regress ing each p lan 's ac tual to ta l
re turn (Qu adra nt IV) agains t , in tu rn , i t s ca lcu la tedco m m o n s t o ck s / b o n d s / cas h eq u i v a l en t s i n v es t -
Table 6. Annualized 10-Year Retums of 91 Large Plans, 197 4-1983
Total Returns Average R et ur n M ini mu m e tu rn Ma xim um eturn Standard Deviation
Portfolio returns
Policy 10.11% 9.47% 10.57% 0.22%Policy and timing 9.44 7.25 10.34 0.52Policy and selection 9.75 7.17 13.31 1.33Actual portfolio 9.01 5.85 13.40 1.43
Act ive re turns
Timing only -0.66% -2.68% 0.25% 0.49%Security selection only -0.36 -2.90 3.60 1.36Othe r -0.07 - 1.17 2.57 0.45
Total activ e return -1.10% -4.17%* 3.69%* 1.45%*
* Not additive.
Act ive management (and therefore i t s cont ro l )
i s c lear ly impor tan t . But how impor tan t i s i t re la-
t ive to inves tment po l icy i t se l f? The re la t ive mag-
n i t u d es i n d i ca t e t h a t i n v es t m en t p o l i cy p ro v i d es
the l arger por t ion of re turn . This is no t surpr i s ing
in i t se l f , and mos t would not d i sagree that the
"v a l u e ad d ed " f ro m ac t i v e m an ag em en t i s s m a l l
( though impor tan t ) re la t ive to asset c lass re turns as
a wh o l e . H o wev er , w h a t d o es t h is i m p l y ? It i m -
pl ies that i t i s the normal asset c lass weights and
the pass ive asset c lasses themselves that p rovidethe bulk of re turn to a por t fo l io .
No t e t h a t t h e r an g e o f o u t co m es an d s t an d a rd
devia t ions of po l icy re turns i s small , ref l ec t ing the
historical tendency of s imilar ( large, corporate)
p lans to grav i ta te tow ard the same pol icy mix . We
would expect that , over t ime, as p lan sponsors
dedicate more resources to the po l icy a l locat ion
me nt po l icy re turn (Qu adra nt I ), po l icy and t iming
return (Qua drant I I) and pol icy and se lect ion re-
turn (Quadrant I I I ) . The value in each quadrant
thus has 91 regress ion equat ions behind i t , and the
n u m b er s h o w n i s t h e av e rag e o f 9 1 u n ad j u s t e dR-squares of the regress ions . ~
The resul ts are s t r iking. Natural ly, the total
p lan pe rform ance expla ins 100 per ce n t o f i t se l f
(Qu adra nt IV) . But the inves tm ent po l icy re turn in
Qu ad ran t I ( n o rm a l we i g h t s an d m ark e t i n d ex
returns ) expla ined o n average fu l ly 93 .6 per cen t o f
the total variat ion in actual plan return; in part ic-u lar p lans i t expla ined no less than 75 .5 per cen t
and up to 98 .6 per cen t o f to ta l re turn var ia t ion .
R e t u rn s d u e t o p o li cy an d t i m in g ad d ed m o d es t l y
to the expla ined var iance (95 .3 per cen t ) , as d id
policy and securi ty select ion (97.8 per cent) . Tables
6 and 7 c lear ly show that to ta l re turn to a p lan i s
d o m i n a t ed b y i n v es t m en t p o l i cy d ec is i on s . Ac t iv e
136 Financial Analysts Journal / January-February 1995
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1985-1994
Table 7. Percentage of Total Return VadaUonExplained by Investment Activity, Averageof 91 Plan.% 197 3-1985
<
SelectionActual Passive
(IV) (II)
100.0% 95.3%
(III) (I)97.8% 93.6%
Variance Explained
StandardAverage Minimum Maximum Deviation
Policy 93.6% 75.5% 98.6% 4.4%Policy an d 95.3 78.7 98.7 2.9
timingPolicy an d 97.8 80.6 99.8 3.1
Selection
m a n a g e m e n t , w h i le i m p o r t a n t ; d e s c ri b e s f ar l e ss
o f a p l a n ' s r e t u r n s t h a n i n v e s t m e n t p o l i c y .
IMPUCATIONS
Des ign Of a portfol io involv es at least fou r s teps:
• d e c i d i n g w h i c h a s s e t c l a s se s t o i n c l u d e
a n d w h i c h t o e x c l u d e f r o m t h e p o r t f o -
lio;
• d e c i d i n g u p o n t h e n o r m a l , o r l o n g -
t e r m , w e i g h t s f o r e a c h o f t h e a s s e t
c l a s s e s a l l o w e d i n t h e p o r t f o l i o ;
• s t r a t e g i c a l l y a l t e r i n g t h e i n v e s t m e n t
m i x w e i g h t s a w a y f r o m n o r m a l i n a n
a t t e m p t t o c a p t u r e e x c e s s r e t u rn s f r o m
s h o r t - t e r m f l u c t u a t i o n s i n a s s e t c l a s s
p r i c e s ( m a r k e t t i m i n g ) ; a n d
• s e l e c t i n g i n d i v i d u a l s e c u r i t i e s w i t h i n a n
a s s e t c l a ss t o a c h i e v e s u p e r i o r r e t u r n s
r e l a t i v e t o t h a t a s s e t C l a s s ( s e c u r i t y s e -
l ec t i o n ) .
T h e f i r st t w o d e c i s i o n s a r e p r o p e r l y p a r t o f i n v e s t -
m e n t p o l ic y ; t h e l a s t t w o r e s i d e i n th e s p h e r e o f
i n v e s t m e n t s t r a t e g y . B e c a u s e o f i ts re l a t iv e i m p o r -
t a n c e , i n v e s t m e n t p o l ic y s h o u l d b e a d d r e s s e d c a r e-
f u l l y a n d s y s t e m a t i c a l l y b y i n v e s t o r s .
F u t u r e a t t e m p t s t o q u a n t i f y t he i m p o r t a n c e o f
i n v e s t m e n t m a n a g e m e n t d e c i s io n s t o p o r tf o l io
p e r f o r m a n c e w o u l d b e n e f i t f r o m a n e x a m i n a t i o n o f
t h e i n t e g r a t i o n o f i n v e s t m e n t p o l i c y a n d i n v e s t -
m e n t s t r a t e g y . A n e x p li c it d e l i n e a t i o n a n d r e c o g -
n i t i o n o f t h e l in k s b e t w e e n i n v e s t m e n t p o l i c y a n d
i n v e s t m e n t s t r a t e g y w o u l d h e l p t o c l ar if y f u r t h e r
t h e r o l e o f b o t h a c t iv i ti e s i n t h e i n v e s t m e n t p r o -
c e s s . A s i m p l e a n d a c c u r a t e , y e t c o m p l e t e a n d
m e a s u r a b l e , r e p r e s e n t a t i o n o f t h e i n v e s t m e n t d e -
c i s i o n - m a k i n g p ro c e s s w o u l d f u r t h e r o u r u n d e r -
s t a n d i n g o f t h e i m p o r t a n c e o f t h e v a r i o u s c o m p o -
n e n t s o f i n v e s t m e n t a c t i v i ty a n d , w e h o p e , l e a d t o
a co n c is e a n d i n t e g r a t e d f r a m e w o r k o f i n v e s t m e n t
r e s p o n s i b i l i t y .
FOOTNOTES
1. SEI Corporation, Number of Managers by Plan Size (Wayne,Pennsylvania, 1985):1.
2. See W.R. G ood, "'Accountability for Pension Perform ance ,"Financial Analysts Journal (January/February 1984):39-42.
3. Early works include E.F. Fama, "Com pone nts of InvestmentPerformance," The Journal of Finance (June 1972):551-67, andM.C. Jensen, "The Performance of Mutual Funds in thePeriod 1945-1964," The Journal of Finance (May 1968):389-416. Some more recent w orks have clearly forged ahead. A san excellent example, see J.L. Farrell, Jr., Guide to Portfolio
Management (New Y ork: McGraw-H ill, 1983):321-39.4. For a clear treatment of policy versus strategy, see D.A.Love, "Editorial Viewpoint," Financial Analysts Journal
(March/April 1977):22. For a discUssion of norm al portfolios,see A. Rudd and H.K. Clasing, Jr., Modern Portfolio Theory(Hom ewood, IlL: Dow Jones-Irw in, 1982):71-72.
5. We say "specified" ewm thou gh the actual weights may notbe known in advance; this accounts for those who wish touse portfolio insurance techniques. In our view, these tech-niques are more ones of active asset allocation (market
6.
7.
timing) than investment policy. We view investment Policyas having an indefinite time horizon, as opposed to a
specific, though extendable, one.Throughout this article we will use the words "normal,"
"benc hmark" and "pass ive" interchangeably. For a detaileddescription on how an investment policy can be derived, see
G.P. Brinson, J.J. Diermeier , an d G .G. Schlarbaum, "AComposite Portfolio Benchmark for Pension Plans," Finan-
cial Analysts Journal (March/April 1986):15-24.
While this is clearly a simplification, we are unable to
address more accurately the problem of normal weights.Since 10 years covers several business cycles, and since theaverage standard deviation of asset class holdings for com-mon stocks and bonds is not high relative to the averageamounts held, this is probably not a serious problem in theanalysis.
Data for benchm ark returns were prov ided by R.G. Ibbotson& Associates (Chicago, Ill.) and Shearson/Lehman AmericanExpress (New York).
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1985-1994
8. We a l so c a lc u la te d the s toc k/bonds /c a sh e quiva le nt s r e turn
se r ie s a nd , in a l l o f the a na lys i s tha t fo l lows, a l so use d tha t
c a l cu l a t ed r e t u r n w h e r e v e r w e u s e d t h e a c t u al f u n d r e t u r n ;
results were s imilar in a l l cases .
9 . B y " u n a d j u s t e d , " w e m e a n t h a t t h e R - sq u a r e d m e a s u r e s ar e
not a d jus te d for de gre e s of f r e e dom ; thus , for our thre e
s im ple r e gre s s ion m ode l s , the R-squa re d r e p re se nt s a squa re
of the c or re la t ion Coe f f i c ie n t , a nd r e pre se nt s the a m ount of
va r ia nc e of to ta l r e turn e xpla ine d in e xc e s s of the a ve ra ge .
Whi le the a ve ra ge of the qua r te r ly to ta l r e turns m a y not be
pre dic ta b le , i t i s none the le s s of in te re s t ex post a nd, in
e s se nc e , c a n be spe c i fi e d by the pa s s ive por t fo l io tha t , whe n
e s t a b li s h e d , b e c o m e s t h e r e l e v a n t b e n c h m a r k f o r a n y f u r t h e r
c o m p a r i s o n .
138 Financial Analysts Jo um al / January-February 1995