Abstract

In order to delineate investment responsibility and measure performance contribution, pension plan sponsors and investment managers need a clear and relevant method of attributing returns to those activities that compose the investment management process—investment policy, market timing, and security selection. The authors provide a simple framework based on a passive, benchmark portfolio representing the plan's long-term asset classes, weighted by their long-term allocations. Returns on this "investment policy" portfolio are compared with the actual returns resulting from the combination of investment policy plus market timing (over- or underweighting within an asset class). Data from 91 large U.S. pension plans over the 1974-83 period indicate that investment policy dominates investment strategy (market timing and security selection), explaining on average 95.6 percent of the variation in total plan return. The actual mean average total return on the portfolio over the period was 9.01 percent, versus 10.11 percent for the benchmark portfolio. Active management cost the average plan 1.10 percent per year, although its effects on individual plans varied greatly, adding as much as 3.69 percent per year. Although investment strategy can result in significant returns, these are dwarfed by the return contribution from investment policy—the selection of asset classes and their normal weights.

About the Author(s)

Gary P. Brinson CFA

Gary P. Brinson, CFA, is the president of GP Brinson Investments. Previously, he founded Brinson Partners, Inc., and served as chairman of the Institute of Chartered Financial Analysts, a predecessor of CFA Institute. Mr. Brinson is a member of the Economic Club of Chicago and the advisory council of the Financial Analysts Journal. He was named Outstanding Financial Executive by the Financial Management Association and received the CFA Institute Award for Professional Excellence. Mr. Brinson is the co-author of two books on global investing and has written numerous articles on an array of investment topics. He holds a BA in finance from Seattle University and an MBA from Washington State University.

L. Randolph Hood

L. Randolph Hood, CFA, is a retired managing director and CIO of Prudential Financial’s pension plan based in New Jersey.

Gilbert L. Beebower

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