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Reading 19: Asset Allocation EOC Q1B (Source: CFAI)

Hi guys

Not sure how important this is but I would like to understand why the answer is related to time-series and cross sectional sense. Please help!

Question: Discuss the effects of the following implementation choices on the measured importance of RFM’s policy portfolio:
i. rebalancing to the policy mix.
ii. investing actively within an asset class or indexing to asset.
iii. adopting a policy portfolio that is much different from those of peers.

Answer:
i. The more frequently RFM rebalances to its strategic asset allocation, the more important strategic asset allocation will appear in a time-series sense as in Brinson, Hood, and Beebower (1986).
ii. If RFM chooses to index, the measured time-series importance of strategic asset allocation will increase, but it will decrease if RFM actively manages within asset classes, all else equal. This effect will occur because the percent of total variation explained by security selection will increase. Active management will also tend to decrease the measured cross-sectional importance of asset allocation.
iii. By itself, choosing a policy portfolio that is distinct from one’s peers should not affect asset allocation’s measured importance in a time-series sense. It will tend to differentiate RFM’s returns from those of its peers, however, and tend to make asset allocation appear important in a cross- sectional sense.

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