Does Asset Allocation Influence Portfolio
Performance?: Evidence From University Endowment Funds
Keith C. Brown
Lorenzo Garlappi
Cristian Tiu
Abstract
In an efficient market, the
asset allocation decision is the sole determinant of a portfolio's expected
return. Using a unique data set for university endowment funds, we test this hypothesis
and find the evidence to be strongly contradictory. We show that although
endowments differ substantially in their capital commitments to various asset classes,
the volatility and the associated policy portfolio returns are remarkably similar
across the sample, indicating that asset allocation is unrelated to returns in
the cross section. Moreover, while the risk-adjusted performance of the average
endowment is not reliably different from zero, more actively managed funds
generate statistically and economically significant annual alphas that are
three to six percent greater than those for more passive endowments. This
finding is consistent with endowment managers attempting to exploit their
security selection ability by over-weighting asset classes in which they appear
to have superior active management skills. Finally, we demonstrate that the
average endowment in our sample under-utilizes active management and that its
out-of-sample performance would improve by taking more active risk while
keeping its policy allocation unaltered. Contrary to both efficient market
theory and prevailing industry beliefs, we find that asset allocation is not
related to portfolio returns in the cross section but does appear to indirectly
influence risk-adjusted performance.
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