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Key Components of Investment Returns

The Financial Analyst Journal did a study on the key components of portfolio performance. This study showed that 91.5 percent of a portfolio’s investment return is gained through the allocation of the asset classes.  In other words, almost all return is determined by how well diversified the portfolio was.  It did not matter so much what the actual stocks were but what the relationship or correlation was of the stocks in the portfolio.

When an investor owns actively managed mutual funds in their portfolio or they have multiple advisors, this does not mean they are effectively diversified.  Actively managed mutual funds may have similar holdings (stocks) or could have similar asset categories. We call this overlap.

Therefore, with actively managed mutual funds you may have a fund that says Small Cap in its name but actually owns Large Cap stocks.  You think you are are buying Small Cap stocks to better diversify but actually are buying more of the same Large Cap stocks.  This increases your portfolio risk by owning more of the same asset category.

To find out if your portfolio is suffering from overlap, or excessive trading click here.


1 “Determinants of portfolio performance,” Financial Analysis Journal, Gary P. Brinson, L Randolf Hood, and Gilbert L Beebower.  1986 Revisiting Determinants of Portfolio Performance:  “An Update,” Brinson, Singer, Beebower, 1991.  Determinants of Portfolio Performance:  “An Update,” Benson, Singer and Beebower, 1996

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