If a tree falls in a forest and no one is there, does it make a noise? If a very credible and well-recognized investment researcher convincingly refutes an oft-misquoted study and no one pays attention, does that refutation still exist?
The two “BHB” papers—the first one published in 1986 by Brinson, Hood, and Beebower, and the second published in 1991 by Brinson, Singer, and Beebower—are often incorrectly cited as “proof” that asset allocation is responsible for 91.5 percent of a portfolio’s investment returns.
This “evidence” is then used to convince investors (both professionals and retail clients alike) that stock selection doesn’t matter. In the end, goes this logic, asset allocation trumps stock selection.
However we end up here (read “How’d an Innocent Fiduciary Like You End Up Asset Allocating?” FiduciaryNews.com, June 10, 2015), using BHB exposes fairly significant problems. First, that’s not what the paper concluded. BHB merely stated that asset allocation (actually “portfolio policy”) accounted for 91.5 percent of the “variability of returns,” not the returns themselves.
This statement, some have said, is akin to saying “a rising tide floats all boats.” This is not new. We’ve known this since the second paper was published in 1991.
Yet this myth that “asset allocation is responsible for 91 percent of a portfolio’s performance” grew. In today’s terms, you might say it went viral.
That upset not a few academics, whom I’m guessing don’t like to see the work of their colleagues misquoted, misinterpreted, and, in general, used in a misleading way. Apparently, they especially don’t like when this happens to data they consider suspect.
In 2000, Roger Ibbotson, already well-known for his presence in the rarified air among finance professors, conducted a follow-up study to BHB.
He found the myth that stock selection didn’t matter to be just that—a myth.
He wrote about it in 2000 and again in 2010. Other studies confirmed and refined his study.
For the last decade and a half, it’s pretty clear BHB—the rock upon which asset allocation was built (well, at least upon which it was sold to the public) —was not as solid as originally thought.
In a perfect world, BHB would have faded into history. Yet, there it remains, in nearly every investment sales pitch out there.
I’ve noticed, unlike the infamous Vanguard and Fidelity ads which blatantly mischaracterized BHB, today’s pitch generally does use the phrase “variability of returns” somewhere in the body of the text. But the headline still shouts out “What Drives Investment Performance,” clearly implying the hands on the steering wheel belong to our old friend asset allocation.
Asset allocation might have its merits. It might, in fact, be critical in very specific situations. But the reasons for its relevance don’t lie with the false representations of BHB. That we still see BHB being used in industry marketing literature only further condemns the credibility of a sector that can’t afford to jeopardize any more of its trustworthiness.
Collectively, we need to stop using the BHB study. This starts with the compliance departments. Why do they continue to approve marketing collateral that references BHB?
Don’t they know the huge liability risk that assumes? Will it take the trial lawyers to finally convince firms to send BHB down the memory hole of research papers that are past their expiration date?
Worse, does hiding under the skirts of BHB lead financial service providers towards a false sense of security? What if there are bigger problems with asset allocation that we’re missing just because we believe in the sanctity of BHB? What if those problems pose a greater threat than merely misquoting a controversial paper?
Ibbotson’s work has never been successfully challenged. It has been ignored.
Hiding the head of asset allocation in the sand will not change the facts. Sooner or later, a noise will be heard. The only question is: How loud will it be?