Benchmarking in Asset Allocation

Explains why benchmarks are a crucial part of the asset allocation process in investment strategy.

TL; DR

• Benchmarks provide a starting point and standard for comparison in asset allocation.

• Historical research by Brinson, Hood, and Beebower highlights the significant impact of asset allocation on investment outcomes.

• Investors are expanding their view to include the global equity opportunity set as a benchmark.

• Tailoring asset allocation from the global opportunity set can align with specific investor goals and constraints.

• Ignoring the full opportunity set can introduce unintended biases and risks.

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Insights

Asset allocation is a critical component of investment strategy, and the choice of a benchmark (BM) is central to this process. Understanding why benchmarks are important in asset allocation can help investors make more informed decisions.

Starting Point and Comparison

• Benchmarks serve as a starting point for asset allocation, providing a reference against which performance can be measured.

• They offer a standard for comparison, helping investors to evaluate the performance of their portfolios.

Historical Evidence on Asset Allocation Success

• Research, such as the study by G. Brinson, L. Randolf Hood, and G. Beebower in 1986 titled "Determinants of Portfolio Performance," has shown that the success of investment outcomes is predominantly determined by the asset allocation decision process.

Global Equity Opportunity Set

• Investors are increasingly considering the global equity opportunity set as the initial benchmark for their investments.

• This approach allows for a comprehensive view of potential investments before making adjustments based on specific goals, expertise, philosophy, and constraints.

Adjustments Based on Investor Specifics

• Asset allocation decisions can be tailored from the global opportunity set to align with an investor's unique profile.

• This customization ensures that the allocation is relevant and suitable for the investor's objectives.

Consequences of Ignoring the Full Opportunity Set

• Not considering the full opportunity set can lead to unintended bets and biases/risks.

• Overlooking the global set of opportunities can itself be an inadvertent investment decision, potentially leading to suboptimal outcomes.

In summary, benchmarks are essential in asset allocation as they provide a foundation for comparison and decision-making. They help investors to start with a broad perspective before refining their strategy to meet specific investment goals and constraints.