Glossary · Portfolio construction
Asset Allocation
Asset allocation is the division of a portfolio's capital among asset classes such as public equity, fixed income and private markets, and the process of setting, implementing and rebalancing those weights against the investor's objectives and constraints.
An investor first decides how much of the portfolio should sit in each broad type of asset, then fills those buckets with managers and securities. For listed assets the mix can be changed in days. For private funds it cannot: the investor commits money that managers call and return over many years, so the private allocation is steered indirectly, mainly through how much is committed each year.
Layers of the allocation decision
Institutional investors commonly separate four layers. The strategic asset allocation (SAA) sets long-term target weights and permitted ranges for each asset class; the governing body approves it, usually in an investment policy statement. Tactical asset allocation covers deliberate, temporary deviations within those ranges. Implementation fills each class with managers, funds, co-investments or securities. Rebalancing moves weights back toward target when markets push them outside the ranges. Results are judged against a policy benchmark built from the SAA weights.
What asset allocation explains, and what it does not
A widely repeated claim is that asset allocation "explains over 90% of returns". The study usually cited, Brinson, Hood and Beebower (1986), examined 91 large US pension funds over 1974–1983 and found that the policy mix explained 93.6% of the variation in each fund's quarterly returns over time. It did not measure the share of the return level, or the differences between investors. Ibbotson and Kaplan (2000) separated the three questions: policy explained about 90% of a fund's return variability over time, about 40% of the variation in returns across funds, and on average about 100% of the return level. The right figure depends on the question being asked.
Private markets: target, actual and committed exposure
For each private-markets class, from buyout to infrastructure, an investor tracks three numbers. The target is the policy weight. The actual allocation is the reported net asset value of the private holdings divided by total portfolio value at the same date. Committed exposure adds unfunded commitments, which the investor must pay when managers call capital.
The actual weight moves with capital calls, distributions and valuation changes, and with the value of everything else: a fall in public markets raises it mechanically (the denominator effect). Because fund interests cannot be bought or sold at will without cost, the main control is the size of new commitments each year, set through commitment pacing. Private NAVs are fair value estimates reported with a lag; the International Private Equity and Venture Capital Valuation (IPEV) Guidelines state that institutional investors require fair value to make asset allocation decisions, which is why the quality and timing of those marks matter to the allocation itself.
Constraints that differ by investor type
Objectives and constraints differ, so similar-sized investors can hold very different mixes.
- US private foundations other than operating foundations are subject to a 30% tax on undistributed income: the distributable amount for a taxable year, based on a minimum investment return of 5% of the fair market value of their assets not used (or held for use) directly in carrying out their exempt purpose, less acquisition indebtedness on those assets, is taxed to the extent it has not been distributed by the end of the following taxable year (26 U.S.C. section 4942(a), (d) and (e)(1)). This sets a floor on the cash the portfolio must produce.
- EU insurers hold capital against investment risk under Solvency II, and the charges shape allocations to private equity, private debt and infrastructure. Directive (EU) 2025/2, which reviews Solvency II, requires Member States to adopt their transposing measures by 29 January 2027 and apply them from 30 January 2027; it inserts an article on long-term equity investments (Article 105a) into the Solvency II Directive.
- Defined benefit pension plans set allocations against their liabilities (asset-liability management).
- Endowments combine long horizons with a spending policy. In the study by the National Association of College and University Business Officers (NACUBO) and Commonfund for fiscal year 2025 (657 institutions, $944.3 billion of endowment assets), dollar-weighted allocations were 16.8% to private equity and 15.4% to marketable alternatives, and institutions with more than $5 billion allocated 62.5% to alternatives.
Family office asset allocation
A family office allocates for one family or a small group of families, so its constraints are personal rather than statutory: spending and liquidity needs, the family's tax position, and often a large stake in an operating business that already concentrates risk in one industry and region. Governance ranges from formal targets and ranges approved by an investment committee to sleeves managed at the principal's discretion. Many family offices also invest directly and through co-investments, which makes the private allocation lumpier than a fund programme. Published survey figures on family-office allocations vary with sample and method; read any figure with its sample size and date.
How allocation is governed
The governing body (board, trustees, investment committee or principal) approves targets, ranges, rebalancing rules and delegations; staff or an OCIO implement within them. Policies typically answer four questions: how far a weight may drift before action is required; whether private-market weights are measured on NAV alone or on NAV plus unfunded commitments; how often the SAA is reviewed; and who may approve exceptions.
Worked example
Illustrative target, actual and committed exposure
A $20bn pension plan has a 12% private equity target. Its private equity funds report NAV of $2.6bn, so the actual allocation is 13.0%. It also has $1.4bn of unfunded commitments, equal to 7.0% of the plan. Committed exposure (NAV plus unfunded) is therefore 20% of the plan. On NAV the plan is one point over target; on committed exposure it has already promised much more, and next year's commitment budget has to reflect both numbers.
Examples are illustrative; figures are not market data.
Not the same as
- Strategic Asset Allocation (SAA): SAA is the long-term target layer. Asset allocation is the whole process, including tactical deviations, implementation and rebalancing.
- Portfolio Construction: Asset allocation sets how much goes to each asset class; portfolio construction decides how each allocation is filled (managers, vintages, concentration, vehicles).
- Diversification: Diversification is one objective of an allocation. An allocation can be deliberately concentrated, for example around a family's operating business.
Common mistakes
- Quoting "asset allocation explains over 90% of returns". Brinson, Hood and Beebower measured the variation of a fund's quarterly returns over time, not the level of returns or differences between investors.
- Treating a private-markets target as reached once commitments equal the target. Commitments are called over several years and capital starts coming back before the last of it is called.
- Ignoring unfunded commitments when assessing liquidity. They are claims on the rest of the portfolio.
- Reading the private weight from NAVs dated one quarter earlier while measuring public assets at today's prices, without saying so.
- Rebalancing private holdings as if they were liquid. Selling fund interests usually means a secondary sale at a price set against NAV.
Edge cases
- Co-investments and direct deals may be reported inside private equity or as a separate sleeve; the choice changes the reported allocation.
- Funds of funds and multi-asset vehicles need look-through exposure to show what the portfolio actually holds.
- Evergreen and semi-liquid vehicles report NAV more often than closed-end funds but may limit redemptions, so frequent NAVs do not mean the weight can be adjusted quickly.
Questions
Does asset allocation explain 90% of investment returns?
Not in the sense usually quoted. Brinson, Hood and Beebower (1986) found the policy mix explained 93.6% of the variation of pension funds' quarterly returns over time. Across funds, Ibbotson and Kaplan (2000) found policy explained only about 40% of return differences.
How is a private markets allocation measured?
Usually as reported NAV divided by total portfolio value at the same date. Many investors also track NAV plus unfunded commitments, because the unfunded amount will be called from the rest of the portfolio.
Sources
- Setting the Record Straight on Asset Allocation. David Larrabee, CFA, CFA Institute (Enterprising Investor), 16 February 2012. Status: Published (checked 2026-10-01). Post of 2012-02-16, discussion of Brinson, Hood and Beebower (1986) — supports: Brinson, Hood and Beebower (1986): 91 US pension funds, 1974–1983; 93.6% of the variation in quarterly returns, not the return level
- Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?. Roger G. Ibbotson; Paul D. Kaplan, Financial Analysts Journal, Vol. 56(1), pp. 26-33, January/February 2000. Status: Published (paywalled) (checked 2026-10-01). Abstract — supports: About 90% of variability over time, about 40% of cross-fund variation and about 100% of the return level explained by policy
- International Private Equity and Venture Capital Valuation Guidelines (2025 edition). IPEV Board, IPEV, Published 11 December 2025; in effect for quarterly reporting periods beginning on or after 1 April 2026; early adoption encouraged. Status: Current; supersedes the December 2022 edition (checked 2026-10-01). Introduction, p. 6 — supports: Institutional investors use fair value to make asset allocation decisions
- 26 U.S.C. 4942 - Taxes on failure to distribute income (private foundation minimum distribution). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Sec. 4942(a)(1), (d), (e)(1) — supports: Tax on a private foundation's undistributed income (not for operating foundations); distributable amount based on the minimum investment return of 5% of the fair market value of assets not used directly in carrying out the exempt purpose
- Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II). European Parliament and Council, Official Journal of the EU, L 335, 17.12.2009, Adopted 25 November 2009; applied from 1 January 2016 (as amended by Omnibus II, Directive 2014/51/EU). Status: In force; amended by Directive (EU) 2025/2 (checked 2026-10-01). Arts. 100–127 (Solvency Capital Requirement) — supports: Risk-based capital regime for EU insurers affecting private-markets allocations
- Directive (EU) 2025/2 amending Directive 2009/138/EC (Solvency II review). European Parliament and Council, Official Journal of the EU, L series, 8.1.2025, Adopted 27 November 2024; transpose by 29 January 2027, apply from 30 January 2027. Status: In force; transposition pending (checked 2026-10-01). Art. 1(48) (inserting Art. 105a 'Long-term equity investments', within the equity risk sub-module of Art. 105(5)); Art. 4(1) (adopt by 29 January 2027, apply from 30 January 2027) — supports: Transposition by 29 January 2027 and application from 30 January 2027; new Art. 105a on long-term equity investments within the market risk capital requirement
- 2025 NACUBO-Commonfund Study of Endowments (FY2025). NACUBO and Commonfund Institute, NACUBO, FY2025 (1 July 2024 - 30 June 2025); released 12 February 2026. Status: Latest edition (checked 2026-10-01). FY2025 press release — supports: Endowment sample size, assets and dollar-weighted allocations for FY2025