Dwarf Manager Variability – Getting The Big Things Right by Seth J. Masters, AllianceBernstein
In a recent post, I argued that most investors and their financial advisors (wrongly) focus on relative returns because they can: There’s lots of data to look at. Unfortunately, focusing on relative returns tends to lead to performance chasing, which often destroys wealth.
But even if investors could restrain themselves from chasing performance, obsessing about relative returns doesn’t make sense. Many studies have shown that asset allocation is far more important to long-term portfolio outcomes.*
The importance of asset allocation to long-term returns can be seen in the Display below, which shows the range of rolling one-year returns for indexes representing various traditional asset classes over the last 25 years in blue, and the range of relative returns earned by active managers in each asset class in light blue. Each bar spans returns from the top to the bottom decile of 12-month performance; each diamond represents the median result. As you can see, the range of annual index returns for each asset class is far greater than the range of manager returns relative to the index.
For example, returns for the S&P 500 index of US stocks ranged from (14)% to 30%: a spread of 44 percentage points. Relative returns earned by active managers of US stocks varied much less: from (8)% to 5%, a spread of 13 percentage points. The range of returns for bonds was much narrower than for stocks, but for bonds, too, index returns were significantly more variable than manager performance.
In other words, fluctuations in market returns (or beta) have been far more important to investor returns than manager skill (or alpha).
Does that mean it doesn’t matter whether you go with a winning or losing manager? Not at all: Every bit of return helps. And since we expect market returns to be modest over the next five to 10 years, we think that an extra boost from manager alpha will be particularly helpful. Even so, the impact of any manager alpha on your long-term investment results will likely be trumped by the impact of your asset-allocation beta decision.
*Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, “Determinants of Portfolio Performance,” Financial Analysts Journal , July–August 1986; and Brinson, et. al, “Determinants of Portfolio Performance II: An Update,“ Financial Analysts Journal, May–June 1991.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
