Asset allocation vs Security selection

Hi everyone, Because we compare the portfolio return to a benchmark, then : asset allocation is the ability of the portfolio manager to define better weights of the benchmark’s securities (only) in his portfolio to beat the benchmark security selection is the ability of the portfolio manager to select securities _ different _ from the benchmark to beat the benchmark basically, a portfolio with only benchmark securities would generate 0 security selection value added !

Is that correct ? If not, could you give me an example… :wink: Thank you !

That’s not quite correct.

Asset allocation return = return achieved from different asset weightening among managers and/or portfolios.

Security selection return = return achieved from particular stock selection.

All of above might be achieved within same asset class (eg. equity) but with different characteristics (sectors, value/growth stocks etc).

A portfolio with only benchmark securities may reach asset allocation return and thus an active return if those securities are differently weighted in portfolio related to benchmark. Also portfolio manager maybe can short sell some of those securities.

If the securities within the portfolio are exactly equal to the securities in the benchmark than the portfolio cannot generate any alpha by way of security selection however despite having identical holdings, it can assign different weights (asset allocation) than the benchmark which means that the portfolio could generate alpha by way of asset allocation.

In order to generate any alpha by security selection, the portfolio would have to deviate from the benchmark’s holdings in some way. It can choose to include or omit some of the securities seen in the benchmark.

I hope this helps!