Overall pension fund performance may be seen as the net result of contributions from three separate sources—investment policy, portfolio manager strategy and plan-sponsor strategy. Investment policy defines the asset-allocation plan that best meets the fund’s long-term objectives in the absence of active management. Its contribution to overall performance may be quantified as the weighted average of the returns for the component asset groups.

Any significant departure from investment policy represents an exercise of investment strategy by either the plan sponsor or the individual managers. The total contribution of strategy to fund performance is thus the difference between actual fund performance and the return attainable by strict adherence to investment policy.

To distinguish between plan-sponsor contributions and manager contributions, it is necessary to characterize each manager by an index that represents his “normal” portfolio position. The manager is accountable for the difference between the actual performance of his portfolio and the returns attributable to his index. The contribution of plan-sponsor strategy may then be seen as the difference between the aggregate performance of the managers’ indexes and the returns calculated for investment policy.