As every financial planner knows, and every client is told, more than 90% of a portfolio's return can be credited to asset allocation. The source of this received wisdom is the 1986 study, Determinants of Portfolio Performance, by Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower, which was published in the Financial Analysts Journal (FAJ). But hang on for a moment. This 90% figure turns out to be one of the most misquoted and misunderstood factoids in finance.

Brinson and his co-authors actually found something slightly different, that 93.6% of the variation of returns among funds (rather than levels of return) is explained by asset allocation policy. Even this more nuanced finding set off a controversy about its meaning that has been simmering among investment researchers for the past 20 years. Is asset allocation really that important? And if it's not, what is?

The most recent entry in this long-running battle to understand sources of a portfolio return comes courtesy of Roger Ibbotson, founder of Ibbotson Associates (now part of Morningstar). With co-authors James X. Xiong, Thomas M. Idzorek and Peng Chen, Ibbotson has tackled the question, perhaps definitively, in the study Asset Allocation and Investment Strategy are Equally Important, which was published in FAJ in July 2009.

This year-old study should be of great interest to planners-and their clients-as it clarifies the main historical sources of portfolio returns. It also explains why different researchers tend to come up with such incongruous results, while seeming to ask the same question. "Our study corrects the confusion that has existed for several decades. Asset allocation is important but previous numbers were incorrect," Ibbotson says.

WHAT EXPLAINS RETURNS?

According to Ibbotson's research, the overwhelming portion of any portfolio's returns is attributable purely to beta-the movement of the markets. What Brinson characterized as asset allocation also incorporates this basic decision to invest, as opposed to holding cash. In Ibbotson's study, in fact, roughly 70% of returns spring from this simple decision and the market movement it embraces.

How does this affect you, the financial advisor? Today, with many investors feeling gun-shy after the market crash, it makes your role as enforcer of investing discipline all the more important. But it doesn't give you a solution to how best to deploy assets.

The next question is, how important is asset allocation relative to security selection for the return of the typical investment portfolio? As the authors phrase the query, "Is the difference in returns among funds due to asset allocation policy or active portfolio management?" And here is where the study provides new answers.

ALLOCATION VS. SELECTION

Comparing the difference in returns among a group of similar funds-but not their returns overall-it turns out that about half is explained by security selection and half by what Ibbotson calls "fine asset allocation"-that is, choosing among available investment classes (such as stocks versus bonds).

Take balanced funds, for example. The variance in returns among balanced funds is about 50% due to securities selection-the managers' skill, or lack thereof, at picking stocks and bonds-and 50% due to tactical asset allocation mix.

The study examined two portfolio peer groups, one equity-only and one balanced, from Morningstar's U.S. mutual fund database over a 10-year period starting in May 1999. "This is an empirical result," explains Thomas Idzorek, CIO of Ibbotson Associates and one of the paper's co-authors. "It depends upon the sample-the time period and the funds being studied." What that means: the stock vs. bond decision had greater import than which stocks and sectors managers chose.

Therefore asset allocation is important, but not as important as people who misquote Brinson believe. Rather than 90%, a 50% effect is a more realistic number, at least when determining the role asset allocation plays in determining differences in performance between Fund A and Fund B.

Yet in a larger sense-of being in the market or not-asset allocation is critical. This may be the most important lesson a financial advisor can share with clients.

"At least 70% of returns come from the decision to invest in the stock itself. The remaining difference is split between active management and asset allocation," says Morningstar spokesperson Alexa Auerbach. The impact of the market return could be seen in 2008: Virtually all funds, regardless of their asset allocation mix or their managers' stock-picking prowess, were down. And in 2009 they were up.

Ibbotson interprets his results this way: "Financial planners have a big impact, and they should know the source of risk." Will these new, nuanced findings help advisors make better investment decisions? Will they help them manage client expectations more effectively? For once, Ibbotson doesn't have the answer. "I'm not sure if these findings will change planners' thinking and understanding, but I'm hoping they will."