Morningstar Advisor - April/May 2010 - 31

Exhibit 3 Consistent Answers: By placing time series and cross-sectional regressions on equal footing, asset-allocation decisions in excess of market movement and active management are about equally important at explaining return variations.
Time Series and Cross-Sectional R-Squared Distributions
Frequency Excess-Market Time-Series Cross-Sectional

Long Live Asset Allocation

0.25 0.2 0.15 0.1 0.05 0%
R^2

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Exhibit 4 Market Movement Dominates: BHB attributed the bulk of total return variations to asset-allocation policy (left two bars). In contrast, HEI & IK argue that market movement dominates (right two bars).
Decomposition of Total-Return Variations
Asset-Allocation Policy Investment Strategy R-Squared Market Movement Excess-Market Asset-Allocation Policy Interaction Effect*

Investors understand that asset allocation is important, but the answer to the question of how important is tricky. Unfortunately, BHB’s landmark article unintentionally created the fallacy that 90% of return levels come from asset allocation. Investors would do well to forget the 90% number. In aggregate, 100% of return levels come from asset allocation. Return variations are dominated by the common market factor embedded in the funds being analyzed. After removing this common market factor, on average for typical funds about half of the return variations comes from detailed asset-allocation decisions in excess of the market movement and about half of the return variations comes from active management, although this 50/50 result dramatically changes from one period to the next. Our research clarifies the contribution of each and highlights the significant contribution from market movement. For aggregate return levels, asset allocation is king! K
Thomas M. Idzorek, CFA, is chief investment officer at Ibbotson Associates, a Morningstar company. References
Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower. 1986. “Determinants of Portfolio

120% 100 80 60 40 20 0 –20 BHB Equity Funds
Time-Series Regressions

Performance.” Financial Analysts Journal, July/August, pp. 39–44.
Hensel, Chris R., D. Don Ezra, and John H. Ilkiw. 1991. “The Importance of the Asset Allocation Decision.” Financial Analysts Journal, July/August, pp. 65–72. Ibbotson, Roger G., 2010. “The Importance of Asset Allocation.” Financial Analysts Journal, March/April. Ibbotson, Roger G., and Paul Kaplan, 2000. “Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?” Financial Analysts Journal, January/ February, pp. 26–33.

BHB Balanced Funds

HEI & IK Equity Funds

HEI & IK Balanced Funds
Vardharaj, Raman and Frank J. Fabozzi. 2007. “Sector, Style, Region: Explaining Stock Allocation Performance,” Financial Analysts Journal, May/June, pp. 59–70. Xiong, James X., Roger G. Ibbotson, Thomas M. Idzorek, and Peng Chen, 2010. “The Equal Importance

*The interaction effect is a balancing term that makes the three return components of R-squared add up to 100%.

of Asset Allocation and Active Management,” Financial Analysts Journal, March/April.

MorningstarAdvisor.com 31


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Morningstar Advisor - April/May 2010

Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2010

Morningstar Advisor - April/May 2010
Contents
New On MorningstarAdvisor.com
Contributors
Letter from the Editor
Our Job: Building Better Investors
What’s Your Biggest Long-term Concern for the Economy?
An Early Start
Women’s Work
Investment Briefs
Markowitz 2.0
Asset Allocation Is King
A Decade of Riskier Assets ...
... but with plenty of Silver Linings
Be Prepared
Facing up to the Economy’s Problems
Levelheaded
Surviving on Conviction
Four Picks for the Present
Pharmaceutical Firms Get the Urge to Merge
Funds That Look Cheaper Than the Market
Finding Dividend Leaders
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks with Wide Moats
VAs: Assets Rise as New Sales Slip
New at Morningstar
When You Wish Upon a Star
Morningstar Advisor - April/May 2010 - Morningstar Advisor - April/May 2010
Morningstar Advisor - April/May 2010 - Cover2
Morningstar Advisor - April/May 2010 - 1
Morningstar Advisor - April/May 2010 - 2
Morningstar Advisor - April/May 2010 - Contents
Morningstar Advisor - April/May 2010 - 4
Morningstar Advisor - April/May 2010 - 5
Morningstar Advisor - April/May 2010 - New On MorningstarAdvisor.com
Morningstar Advisor - April/May 2010 - 7
Morningstar Advisor - April/May 2010 - Contributors
Morningstar Advisor - April/May 2010 - Letter from the Editor
Morningstar Advisor - April/May 2010 - 10
Morningstar Advisor - April/May 2010 - Our Job: Building Better Investors
Morningstar Advisor - April/May 2010 - 12
Morningstar Advisor - April/May 2010 - 13
Morningstar Advisor - April/May 2010 - What’s Your Biggest Long-term Concern for the Economy?
Morningstar Advisor - April/May 2010 - 15
Morningstar Advisor - April/May 2010 - An Early Start
Morningstar Advisor - April/May 2010 - 17
Morningstar Advisor - April/May 2010 - Women’s Work
Morningstar Advisor - April/May 2010 - 19
Morningstar Advisor - April/May 2010 - Investment Briefs
Morningstar Advisor - April/May 2010 - 21
Morningstar Advisor - April/May 2010 - Markowitz 2.0
Morningstar Advisor - April/May 2010 - 23
Morningstar Advisor - April/May 2010 - 24
Morningstar Advisor - April/May 2010 - 25
Morningstar Advisor - April/May 2010 - 26
Morningstar Advisor - April/May 2010 - 27
Morningstar Advisor - April/May 2010 - Asset Allocation Is King
Morningstar Advisor - April/May 2010 - 29
Morningstar Advisor - April/May 2010 - 30
Morningstar Advisor - April/May 2010 - 31
Morningstar Advisor - April/May 2010 - 32
Morningstar Advisor - April/May 2010 - 33
Morningstar Advisor - April/May 2010 - A Decade of Riskier Assets ...
Morningstar Advisor - April/May 2010 - ... but with plenty of Silver Linings
Morningstar Advisor - April/May 2010 - 36
Morningstar Advisor - April/May 2010 - Be Prepared
Morningstar Advisor - April/May 2010 - 38
Morningstar Advisor - April/May 2010 - 39
Morningstar Advisor - April/May 2010 - 40
Morningstar Advisor - April/May 2010 - 41
Morningstar Advisor - April/May 2010 - 42
Morningstar Advisor - April/May 2010 - 43
Morningstar Advisor - April/May 2010 - Facing up to the Economy’s Problems
Morningstar Advisor - April/May 2010 - 45
Morningstar Advisor - April/May 2010 - 46
Morningstar Advisor - April/May 2010 - 47
Morningstar Advisor - April/May 2010 - 48
Morningstar Advisor - April/May 2010 - 49
Morningstar Advisor - April/May 2010 - Levelheaded
Morningstar Advisor - April/May 2010 - 51
Morningstar Advisor - April/May 2010 - 52
Morningstar Advisor - April/May 2010 - 53
Morningstar Advisor - April/May 2010 - Surviving on Conviction
Morningstar Advisor - April/May 2010 - 55
Morningstar Advisor - April/May 2010 - 56
Morningstar Advisor - April/May 2010 - 57
Morningstar Advisor - April/May 2010 - Four Picks for the Present
Morningstar Advisor - April/May 2010 - 59
Morningstar Advisor - April/May 2010 - 60
Morningstar Advisor - April/May 2010 - Pharmaceutical Firms Get the Urge to Merge
Morningstar Advisor - April/May 2010 - 62
Morningstar Advisor - April/May 2010 - 63
Morningstar Advisor - April/May 2010 - Funds That Look Cheaper Than the Market
Morningstar Advisor - April/May 2010 - 65
Morningstar Advisor - April/May 2010 - Finding Dividend Leaders
Morningstar Advisor - April/May 2010 - 67
Morningstar Advisor - April/May 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - April/May 2010 - 69
Morningstar Advisor - April/May 2010 - 70
Morningstar Advisor - April/May 2010 - 71
Morningstar Advisor - April/May 2010 - 50 Most Popular ETFs
Morningstar Advisor - April/May 2010 - 73
Morningstar Advisor - April/May 2010 - Undervalued Stocks with Wide Moats
Morningstar Advisor - April/May 2010 - 75
Morningstar Advisor - April/May 2010 - VAs: Assets Rise as New Sales Slip
Morningstar Advisor - April/May 2010 - 77
Morningstar Advisor - April/May 2010 - 78
Morningstar Advisor - April/May 2010 - New at Morningstar
Morningstar Advisor - April/May 2010 - When You Wish Upon a Star
Morningstar Advisor - April/May 2010 - Cover3
Morningstar Advisor - April/May 2010 - Cover4
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