What is the relative importance of asset allocation policy versus active
portfolio management in explaining variability in performance? Considerable
confusion surrounds both time-series and cross-sectional regressions and the
importance of asset allocation. Cross-sectional regressions naturally remove
market movements; therefore, the cross-sectional results in the literature are
equivalent to analyses of excess market returns even though the regressions were
performed on total returns. In contrast, time-series analyses of total returns
do not naturally remove market movements. Time-series analyses of excess market
returns and cross-sectional analyses of either total or excess market returns,
however, are consistent with each other. With market movements removed, asset
allocation and active management are equally important in determining portfolio
return differences within a peer group. Finally, an examination of
period-by-period cross-sectional results reveals why researchers using the same
regression technique can get widely different results.