🧐 Asset allocation, active funds vs ETFs selection : what should investors focus on to build optimal portfolios?

20 December 2021

Is asset allocation the only crucial choice to build optimal portfolios? What academics tell us about the importance of selecting the right investment vehicule? Is there a need for a tool to help investors selecting the right investment vehicule?

Is asset allocation the only crucial choice to build optimal portfolios?

To build a portfolio, many investors primarily focus on asset allocation. In the late 1980s, Brinson, Hood, and Beebower published a famous article showing that asset allocation explained over 90% of the variability in a portfolio's return over time. In other words, 93.6% of fund’s ups and downs is explained by its policy benchmarks?

In fact, all broadly diversified portfolios are exposed to the systematic (undiversifiable) risk factors of financial markets, such as business cycles and interest rates. An assessment of what drives the performance of a diversified portfolio over time is likely to find a strong relationship between the performance of a static portfolio made up of market benchmarks and the performance of an actual portfolio made up of asset-class exposures similar to those represented by the benchmarks.

What academics tell us about the importance of selecting the right investment vehicule?

But the Brinson study does not say anything about the dispersion of return among investment managers. In other words, how much of the difference between two funds’ performance is a result of their policy difference? Idiosyncratic risks and differential exposure to systematic risk factors (factor or tactical bets) can create significant performance variation across portfolios. Although diversified portfolio returns move in tandem with broad markets over time, actual returns can vary. Other studies, (Ibbotson & Kaplan 2000) have, on their side, demonstrated that asset allocation and active management selection decisions were equally important to explain the dispersion of returns among funds.

Is there a need for a tool to help investors selecting the right investment vehicule?

There are many asset allocation tools developed on the basis of Brinson result and these are widely used by professional investors. Yet, given the developments over the past 30 years, investors now have a much wider choice of investment vehicles: for example, active / passive funds, or even so-called “smart” funds and also ESG funds.  And the low interest rate environment has made the search for all sources of additional returns even more necessary.

👉Therefore, asset allocation is undoubtedly a critical choice to build optimal portfolios, but by no means the only important one. Choosing the right investment vehicle is also important for improving long-term returns in addition to selecting the right asset class. And investors need new tools to guide them. Discover our tool to help investors allocate between active funds and ETFs and build optimal portfoliol on www.bsdinvesting.com

Marlene Hassine Konqui