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What is the relative importance of asset allocation policy versus active portfolio management in explaining variability in performance? Considerable confusion surrounds both time-series and cross-sectional regressions and the importance of asset allocation. Cross-sectional regressions naturally remove market movements; therefore, the cross-sectional results in the literature are equivalent to analyses of excess market returns even though the regressions were performed on total returns. In contrast, time-series analyses of total returns do not naturally remove market movements. Time-series analyses of excess market returns and cross-sectional analyses of either total or excess market returns, however, are consistent with each other. With market movements removed, asset allocation and active management are equally important in determining portfolio return differences within a peer group. Finally, an examination of period-by-period cross-sectional results reveals why researchers using the same regression technique can get widely different results.

About the Author(s)

James Xiong
James X. Xiong CFA

James X. Xiong, CFA, is head of scientific investment management research at Morningstar Investment Management. He leads research and develops new methodologies and algorithms on the time-varying capital markets model, tail risk management, portfolio optimization, asset allocation, dynamic portfolio choice, insurance product allocation, mutual fund selection, alternative asset class investments, Monte Carlo simulations, and other investment and financial planning areas. Xiong’s work has been published in the Financial Analysts Journal, Journal of Investment Management, Journal of Portfolio Management, Journal of Risk Management in Financial Institutions, and Journal of Financial Planning, among other publications. His co-authored “Liquidity Style of Mutual Funds” was awarded with a Graham & Dodd Scroll, and his co-authored “Momentum, Acceleration and Reversal” won a Harry M. Markowitz Award. Xiong has published more than 15 papers in scientific journals, including Physical Review Letters, a prestigious world journal in physics. He holds a bachelor’s degree in physics from Wuhan University in China and a doctorate in physics from the University of Houston.

Roger Ibbotson
Roger G. Ibbotson

Roger G. Ibbotson is Professor in the Practice Emeritus of Finance at Yale School of Management and chairman of Zebra Capital Management, LLC, a global equity investment and hedge fund manager. He is founder and former chairman of Ibbotson Associates. Professor Ibbotson conducts research on a broad range of financial topics, including popularity, liquidity, investment returns, mutual funds, international markets, portfolio management, and valuation. He has written numerous books and articles, including Stocks, Bonds, Bills, and Inflation (coauthored by Rex Sinquefield), which is updated annually and serves as a standard reference for information and capital market returns. Professor Ibbotson’s other books include The Equity Risk Premium, Lifetime Financial Advice, and, most recently, Popularity: A Bridge between Classical and Behavioral Finance. He is a regular contributor to and an editorial board member of both trade and academic journals. Professor Ibbotson serves on numerous boards and frequently speaks at universities, conferences, and other forums. He received his bachelor’s degree in mathematics from Purdue University, his MBA from Indiana University, and his PhD from the University of Chicago, where he also taught for more than 10 years and served as executive director of the Center for Research in Security Prices.

Thomas M. Idzorek CFA

Thomas M. Idzorek, CFA, is the global chief investment officer for Morningstar's Investment Management Division, which includes Morningstar's global investment management operations and the company’s three U.S.-based registered investment advisers Ibbotson Associates, Morningstar Associates, and Morningstar Investment Services. He manages the research department and a team of PhD researchers and is responsible for the division's overall research agenda, new product development, and adaptation of best-practices investment approaches across the division. Mr. Idzorek also oversees the investment policy committee for the Investment Management Division and serves on Morningstar's retirement plan committee. Previously, he served as the senior quantitative researcher for Zephyr Associates, where he developed and researched financial models and techniques for inclusion in the company's analytical software. Mr. Idzorek has authored numerous articles on asset allocation topics and has expertise in lifetime asset allocation, strategic asset allocation, tactical (dynamic) asset allocation, liability-relative investing, asset allocation implementation, fund-of-funds optimization, risk budgeting, return-based style analysis, and performance analysis. He received a bachelor's degree in marketing from Arizona State University and a master's degree in business administration from Thunderbird School of Global Management.

Peng Chen CFA

Peng Chen, CFA, is chief executive officer of Asia (ex-Japan) at Dimensional Fund Advisors, where he is also a member Dimensional's Investment Policy Committee. Previously, he served as president of the global investment management division at Morningstar and as president and chief investment officer at Ibbotson Associates. Dr. Chen is a member of the Financial Analysts Journal editorial board and a contributing editor for the Asia Financial Planning Journal. He has been awarded the Financial Analysts Journal's Graham and Dodd Scroll Award three times. Dr. Chen holds a BS in industrial engineering from the Harbin Institute of Technology and a MS and PhD in consumer economics from The Ohio State University.