At a Financial Services Institute of Australasia (Finsia) presentation, Perpetual income and multi-sector group executive Richard Brandweiner asked the audience why the industry was riddled with fund manager of the year awards, while there was not a single asset allocator of the year award.

The question was posed in a jocular way and had the desired effect as it produced general audience hilarity, but it also made people ask why the idea of this award was such a ridiculous proposition? Brandweiner, of course, wanted to achieve exactly that.

"We can all hopefully agree that asset allocation is without doubt the most important thing that we should be doing. Isn't it curious then that that is just not the way the industry works?" he said.

Perhaps part of the explanation is that the influence of asset allocation on performance is still a rather murky area. There is a widespread misconception that asset allocation determines 90 per cent of a fund's returns and this stems from the misreading of a 1986 study by Brinson, Hood and Beebower.

They found that a pension fund's asset allocation policy determined more than 90 per cent of the variation in returns over time. But this study never spoke about the level of returns in absolute terms. The question it answered had more to do with volatility, as it researched deviations over time.

A Roger Ibbotson and Paul Kaplan study of 2000 did look at the differences between competing funds and how much of the variation in returns was explained by asset allocation, and it is the answer to this question that helps explain why there is no asset allocation of the year award.
 
"One of the big confusions is that the Brinson studies have been interpreted as the answer to that very first question: what percentage of my return comes from my asset allocation decisions? This is not a mistake that the Brinson study has made, because they never intended to answer that question, but that is the way that most people interpreted the results," Ibbotson tells Investor Weekly.

"[But] most of us actually are interested in a different question and that is: how are my returns different from other people's returns? How does my fund return differ from your fund return? And this is across funds.

"If you look at the variation across funds, that automatically extracts the market from all funds, because in a bad year all funds go down and in a good year all funds go up.

"But if you look across the funds, it turns out about half of the variation across funds comes from the different asset allocation policies that they have and the other half comes from the different stocks and securities they select and the timing difference and so forth, even the fees that they pay. So those are the things that cause funds to be different from each other."

Ibbotson's work looks at why similar funds achieve different outcomes; it does not look at a fund in isolation to see what the influence of asset allocation is on the end result. The reason for this is because the answer to the latter question is rather straightforward, Ibbotson says.

"The answer to that question turns out to be trivial, because the answer is about 100 per cent, so about all of your return comes from your asset allocation decision because, on average, active management does not produce any excess return," he says.

The return achieved depends completely on how much is allocated to the different asset classes, including equities and bonds, he says.

Therefore, the question of how asset allocation plays a role in determining different outcomes of competing managers is more interesting.

Ibbotson and his various co-authors over the years have come to the conclusion that in this question the impact of asset allocation on the performance variation is roughly the same as active management.

"It tells you that asset allocation decisions are very important decisions. They do matter and they do explain half of variation. But the other decisions are important too," he says.

"It consequently might tell you something about how you should allocate your time and resources."

If asset allocation is equally important as active management or manager selection in determining how well you perform compared to your competitors, than why is the industry still largely built around static asset allocation?

Former FuturePlus Financial Services investments general manager Michael Block says this has much to do with business risk.

"Because the very nature of active management cannot hurt a portfolio much, or really help it that much either, business risk is minimised if that is what one spends most time doing," Block says.

The obsession with relative performance to competing managers, or peer risk, seems to have drawn the attention away from asset allocation decisions to a practice of tinkering at the margins.

"I think it will only change when one fund moves first and wins. Then others will take notice," Block says.
 
Perpetual's Select Balanced Fund, as spruiked by Brandweiner at the Finsia presentation, is an attempt to bring asset allocation back on the agenda and reduce the over-reliance on equities.

AMP Capital Investors is exploring a similar route under the guidance of David Kiddie in its multi-asset team.

But the success of these strategies is largely at the mercy of the stock markets, Block says.

"If equities do really well, these strategies will do poorly and will be seen as silly. If they win, they will be seen as really clever. Time will tell," he says.

The fierce competition between managers does not only shift the attention away from asset allocation, but also creates other unwanted investment practices, University of Technology Centre for Capital Market Dysfunctionality adjunct professor Jack Gray says.

"If your fund is trying to outperform my fund, the main tool I'm going to use is momentum. I'm going to copy what you do. If you are joining into a stock because it is going up, I'm going to be in the stock. And momentum leads to a misallocation of capital," Gray says.

"Using momentum, which all managers do, is not doing your job. Your job is to effectively and efficiently allocate capital."

So if asset allocation is just as important as active management in relative performance, should the industry stimulate more emphasis on this skill by instituting an asset allocator of the year award?

Ibbotson says this is not a bad idea.

"I think there is no question that people put the majority of their efforts into picking fund managers and picking stocks and picking specific securities. They put relatively a small part of their efforts in asset allocation decisions," he says.

"And yes, there probably should be awards for that, the same way there are awards for the other parts of the industry."

Gray is not opposed to the idea of celebrating asset allocation either, but says measuring on an annual basis means very little.

"It would be good to have an asset allocation of the decade award, because that is when you can really see results," he says.