This study set out to extensively examine the
cost of asset allocation. We introduced a new concept
of optimal asset classification; this concept provides an
upper limit of performance level that a classification
scheme can possibly achieve, so that we can estimate
current classifications’ performance levels. We explicitly
evaluated the two most commonly employed withinstock
classification schemes: style and industry classification.
The expenses of the current classifications were
arguably substantial, and it turned out the cause was their
factor-based approach, which pursues only diversification
potential.
This article’s findings suggest that investment performance
is significantly affected by the employed asset
classification scheme. There is, therefore, a definite need
for investors to be much more careful in selecting an
asset classification. Furthermore, diversification benefits
should not be the sole rationale for asset allocation.