Several different decisions, including asset allocation, security selection and market timing, affect the return to a pension fund (or any investor). The impact of each type of decision can be measured by comparing a portfolio’s actual return with the return on a hypothetical portfolio that does not reflect a particular decision that went into the real portfolio. The critical element in the comparison is defining the naive alternative to the decision.

When asset allocation is the decision being evaluated, the naive alternative is not obvious. If Treasury bills are the appropriate naive alternative, then asset allocation is, as commonly thought, the single decision with the greatest impact on a typical pension fund’s return. But if a diversified mix (such as the average asset mix across large pension funds) is the alternative, then the impact of departing from this naive allocation may be no greater than the impact of other decisions, including security selection.