bhb1986_determinants of portfolio performance

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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 ®



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~


(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



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




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



1985-1994

Table 7. Percentage of Total Return VadaUonExplained by Investment Activity, Averageof 91 Plan.% 197 3-1985

<


(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).




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

bhb1986_determinants of portfolio performance

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